According to the literature, in an expectations-augmented Phillips curve model, opacity is always preferred to transparency on central bank forecasts. By modelling the private sector's behavior explicitly, we show that transparency reduces the shocks. Consequently, transparency can be preferred.central bank, transparency, Phillips curve, shocks.

Daniel Laskar

English

Research Papers in Economics

Central Bank Transparency and Shocks∗
Daniel Laskar†
Paris School of Economics, CNRS and CEPREMAP, France
Abstract
According to the literature, in an expectations-augmented Phillips
curve model, opacity is always preferred to transparency on central
bank forecasts. By modelling the private sector’s behavior explicitly,
we show that transparency reduces the shocks. Consequently, trans-
parency can be preferred.
JEL Classiﬁcation: E52, E58.
Keywords: central bank, transparency, Phillips curve, shocks.
1 Introduction
Following the widespread move toward more central bank (CB) transparency,
there has been a large development of the theoretical literature on CB trans-
parency. In this literature, "reduced form" models, where the underlying
behavior of economic agents is not made explicit, have often been used. This
may not be adequate if the equations of the model actually depend on the
degree of transparency.
Here we will develop such a point in the case of the "expectations-
augmented Phillips curve" model, where employment depends on inﬂation
surprises. Such a model has often been considered in this literature. We will
underline that the shock aﬀecting this equation should depend on the degree
of transparency on CB forecasts. As a consequence, some results obtained
in the literature are biased against transparency. Thus, the literature has
claimed that opacity is better than transparency on CB forecasts because
∗This revised version has beneﬁted from the helpful comments and suggestions made
by an anonymous referee.
†Address: CEPREMAP, 142 rue du Chevaleret, 75013 Paris, France. Ph: 33 (0)1 40
77 84 08. Fax: 33 (0)1 44 24 38 57. E-mail: laskar@pse.ens.fr.
1
h
a
l
s
h
s
-
0
0
5
6
0
2
6
1
,
 
v
e
r
s
i
o
n
 
1
 
-
 
2
7
 
J
a
n
 
2
0
1
1
Author manuscript, published in "Economics Letters 107, 2 (2010) 158-160"
 DOI : 10.1016/j.econlet.2010.01.012transparency prevents the central bank from using inﬂation surprises to sta-
bilize the economy1. Here, by considering an underlying model which makes
the behavior of the private sector more explicit, we show that transparency
on CB forecasts reduces the magnitude of the shock in the Phillips curve.
This eﬀect is favorable to transparency and may dominate the negative eﬀect
underlined in the literature. This implies that transparency can be preferred
to opacity2.
2 A reduced form analysis
We ﬁrst consider the "reduced form model" of the expectations-augmented
Phillips curve. It has been shown in the literature that more transparency
on CB forecasts is harmful in such a model. As a useful benchmark we will
brieﬂy reproduce this analysis here. We have
n = α(π − π
e)+ε (1)
L
CB = An
2 + π
2 (2)
We have α>0 and A>0. Equation (1) indicates that employment n is an
increasing function of inﬂation surprises, where π is the inﬂation rate and πe
the inﬂation rate expected by the private sector. Expectations are rational.
The variable ε represents a zero-mean shock. The CB wants to stabilize
employment and inﬂation according to the loss function (2)3.
To simplify the analysis, the CB is assumed to know4 the shock ε. The
CB chooses π which minimizes LCB, taking the private sector’s expectation
πe as given. This gives the ﬁrst order condition
π = −Aαn (3)
Plugging n given by (3) into (1), we obtain
π =
Aα2
Aα2 +1
π
e −
Aα
Aα2 +1
ε (4)
1See Cukierman (2001), and Geraats (2006) (in the case of "perfect common knowl-
edge"). Note that our analysis is only about transparency on CB forecasts. Other kinds of
transparency have also been considered (see Geraats (2002) for a survey and references).
2Transparency can be preferred to opacity for diﬀerents reasons from the one devel-
oped here (see Cukierman and Meltzer (1986) and Herrendorf (1999)). Therefore, our
contribution is to develop an additional reason why transparency may be preferred.
3In the absence of shocks the CB has an employment objective which can be achieved
without inﬂation surprises, and therefore there is no systematic inﬂationary bias problem.
The analysis is concerned with stabilization policy in response to shocks.
4In Cukierman (2001) the case where the CB has a noisy information on ε is also
considered. This does not change the result that opacity is better.
2
h
a
l
s
h
s
-
0
0
5
6
0
2
6
1
,
 
v
e
r
s
i
o
n
 
1
 
-
 
2
7
 
J
a
n
 
2
0
1
1A tt h eb e g i n n i n go ft h ep e r i o d ,t h eC Bm a yo rm a yn o tr e v e a li t sf o r e c a s t
of the shock. Under full transparency the private sector knows the CB fore-
cast. As the CB has been assumed to know ε, this implies εe
tr = εtr. Then,
by taking expectations of (4) and substracting to (4) we get πe
tr = πtr, which,
using (1), gives
ntr = ε (5)
Under opacity the private sector does not know the CB’s forecast and
has no information about the shock. We therefore have εe = Eε =0 . Then,
taking expectations of (4) gives πe
op =0 , which, using (4), implies πop =
− Aα
Aα2+1ε. Then, from (3) we get.
nop =
1
Aα2 +1
ε (6)
From (2) and (3), at the equilibrium we get
L
CB = A(Aα
2 +1 ) n
2. (7)
The CB prefers opacity to transparency when we have LCB
op <L CB
tr . From
(7), this is equivalent to n2
op <n 2
tr. From (5) and (6), this condition is always
fulﬁlled. Therefore, opacity is always preferred to transparency. The reason
of the result is that opacity leaves the possibility of using inﬂation surprises.
3 Analysis with an underlying model
The expectations-augmented Phillips curve (1) has often been justiﬁed by
the existence of nominal wage rigidity through wage contracts. Here we will
consider a model which makes explicit the underlying behavior of the private
sector5. As in Herrendorf and Lockwood (1997), there is a large number
of trade unions and ﬁrms, with sector speciﬁc skills for households, each
trade union (TU) having a monopoly power in its sector. Each TU wants to
stabilize both employment and the real wage, with a relative weight given by
C ≥ 0, according to the loss function6
L
TU = Cn
2 +( w − π)
2 (8)
5A classical reference is Rogoﬀ (1985). We consider a more general model in the sense
that, beside employment, the wage setters may also want to stabilize the real wage.
6As we are interested only in the response to shocks, we have eliminated any systematic
inﬂation bias by assuming that the employment and real wage targets of the TU are equal
to zero.
3
h
a
l
s
h
s
-
0
0
5
6
0
2
6
1
,
 
v
e
r
s
i
o
n
 
1
 
-
 
2
7
 
J
a
n
 
2
0
1
1As all sectors are alike, w and n can be taken to represent aggregate vari-
ables for the (log) nominal wage and employment, respectively. As the (log)
price level of last period is normalized to zero, w − π is the (log) real wage.
In each sector, the nominal wage is ﬁx e db yt h eT Ua n dt h e ne m p l o y m e n ti s
determined by ﬁrms’ labor demand, according to the standard equation:
n = −γ (w − π)+γz (9)
We have γ>0. Employment is a decreasing function of the real wage.
The variable z is a zero-mean shock (due to a change in productivity of
labor). The model is now given by the three equations (2),(8) and (9).
Each TU ﬁr s td e t e r m i n e st h en o m i n a lw a g ew a n dt h e nt h eC Bd e t e r m i n e s
the inﬂation rate π. As there is certainty equivalence, the nominal wage w
chosen by each TU minimizes LTU under the constraint (9) where, in (8)
and (9), the variables n, π and z have been replaced by their expected values
ne,π e and ze conditional on the information available to the TU. As each
TU is small, it takes πe as given. The ﬁrst order condition implies
w = π
e +
Cγ2
Cγ2 +1
z
e (10)
Plugging this expression of w into (9), we get the expectations-augmented
Phillips curve (1), where we have α = γ and
ε = γ
µ
z −
Cγ2
Cγ2 +1
z
e
¶
(11)
W es e et h a tn o wt h es h o c kε depends on ze. Therefore, this shock changes
when we move from opacity to transparency. As under transparency we have
ze = z, while under opacity we have ze = Ez =0 ,w eg e t
εtr =
1
Cγ2 +1
γz ; εop = γz (12)
The shock is therefore smaller in absolute value in case of transparency.
As we will now see, this makes it possible for transparency to be preferred.
From (7), the CB prefers transparency to opacity if and only if we have
n2
tr <n 2
op. Replacing ε by εtr in (5), and by εop in (6) (and also replacing α
by γ), we get
ntr = εtr ; nop =
1
Aγ2 +1
εop (13)
From (12) and (13), n2
tr <n 2
op is equivalent to C>A .Therefore we get
4
h
a
l
s
h
s
-
0
0
5
6
0
2
6
1
,
 
v
e
r
s
i
o
n
 
1
 
-
 
2
7
 
J
a
n
 
2
0
1
1Proposition 1 The central bank prefers transparency when we have C>A ,
and prefers opacity when we have C<A(with indiﬀerence when C = A).
By modelling the behavior of the private sector more explicitly, we have
shown that the result in favor of opacity found in the literature does not
hold. The CB may prefer transparency on CB forecasts to opacity.
The results can be more intituively explained in the following way. From
(7), as we have indicated, the CB prefers transparency to opacity if and only
if, at the equilibrium, employment is more stabilized under transparency than
under opacity (because, from (3), if employment is more stabilized, then in-
ﬂation is also more stabilized)7. Under transparency, at the equilibrium, the
CB cannot stabilize employment because it cannot create inﬂation surprises,
but the private sector can let the nominal wage respond to the shock, which
helps to stabilize employment. This eﬀect appears through a reduced magni-
tude of the shock εtr in the Phillips curve under transparency. This favorable
response of the private sector to shocks under transparency was not taken
into account in the literature, because the analysis was done by considering
a reduced form Phillips curve where the shock ε was assumed to be given
independently of whether there is transparency or opacity.
Thus, the role of stabilizing employment by responding to the shock,
which is played by the CB under opacity, is played by the private sector
under transparency. The CB would therefore be indiﬀerent between trans-
parency and opacity if the private sector, when reacting to the shock under
transparency, stabilized employment in the same way as the CB would un-
der opacity. This would occur if, under opacity, the CB maximized the same
objective function as the private sector under transparency. This is actually
equivalent to having A = C8.
Therefore, a real choice between transparency and opacity exists only if,
under opacity, the CB maximizes an objective function which is diﬀerent from
the objective function that the private sector maximizes under transparency.
In the case C>A ,the private sector gives a greater relative weight to its em-
ployment objective than the CB. This implies that, under transparency, the
private sector stabilizes employment more than the CB does under opacity.
Therefore, in this case, the CB prefers transparency. When we have C<A ,
7It is therefore not necessary, in each case, to explicitly consider what happens to
equilibrium inﬂation (which is determined by the CB according to (3)).
8Under opacity, as the nominal wage does not respond to the shock, stabilizing inﬂation
becomes equivalent to stabilizing the real wage. (More formally, under opacity we have
ze =0and πe =0 , which, using (10), gives w =0 . This implies that, for the CB under
opacity, we have π2 =( w − π)
2.) Therefore, under opacity, the CB minimizes the same
loss function as the private sector under transparency if and only if we have A = C .
5
h
a
l
s
h
s
-
0
0
5
6
0
2
6
1
,
 
v
e
r
s
i
o
n
 
1
 
-
 
2
7
 
J
a
n
 
2
0
1
1the opposite is true. The private sector gives a smaller relative weight to its
employment objective than the CB, and, consequently, under transparency
the private sector stabilizes employment less than the CB does under opacity.
This implies that the CB prefers opacity in this case.
References
[1] Cukierman, A., 2001, Accountability, Credibility, Transparency, and Sta-
bilization Policy in the Eurosystem, in: C. Wyplosz, ed., The Impact of
E M Uo nE u r o p ea n dt h eD e v e l o p p i n gC o u n t r i e s , Oxford University Press.
40-75.
[2] Cukierman, A. and A. Meltzer (1986), A theory of Ambiguity, Credibility
and Inﬂation under Discretion and Asymmetric Information, Economet-
rica, 54, 1099-1128.
[3] Geraats, P.M., 2002, Central Bank Transparency, The Economic Journal,
112 (November), F532-F565.
[4] Geraats, P.M., 2006, The Mystique of Central Bank Speak, International
Journal of Central Banking,M a r c h ,3 7 - 8 0 .
[5] Herrendorf, B. (1999), Transparency, Reputation, and Credibility un-
der Floating and Pegged Exchange Rates, Journal of International Eco-
nomics, 49, 31-50.
[6] Herrendorf, B. and B. Lockwood, 1997, Rogoﬀ’s "Conservative" Central
Banker Restored, Journal of Money, Credit, and Banking, Vol. 29, No 4
(November, Part 1), 476-495.
[7] Rogoﬀ, K., 1985, The Optimal Degree of Commitment to an Intermediate
Monetary Target, Quarterly Journal of Economics, 100, 1169-1190.
6
h
a
l
s
h
s
-
0
0
5
6
0
2
6
1
,
 
v
e
r
s
i
o
n
 
1
 
-
 
2
7
 
J
a
n
 
2
0
1
1

A theory of Ambiguity,

Accountability, Credibility, Transparency, and Stabilization Policy in the Eurosystem,

Central Bank Transparency,

Rogoﬀ’s &quot;Conservative&quot; Central Banker Restored,

The Mystique of Central Bank Speak,

The Optimal Degree of Commitment to an Intermediate Monetary Target,

Transparency, Reputation, and Credibility under Floating and Pegged Exchange Rates,

Central Bank Transparency and Shocks

http://halshs.archives-ouvertes.fr/docs/00/56/02/61/PDF/laskarcbtransparencyfinalversion.pdf

Central Bank Transparency and Shocks

Abstract

Similar works

Full text

Available Versions

Research Papers in Economics