Board of Governors of the Federal Reserve System
Lars E.O Svensson
Institute for International Economics Studies, Stockholm University
International Economic Review 42 (2001) 369-397
First draft: June 1997
This version: February 2000
We define and study transparency, credibility, and reputation in a model where the central bank’s characteristics are unobservable to the private sector and inferred from the policy outcome. A low-credibility bank optimally conducts a more expansionary policy than a high-credibility bank, in the sense that it induces higher inflation, but a less expansionary policy in the sense that it induces lower inflation and employment than expected. Increased transparency makes the bank’s reputation and credibility more sensitive to its actions. This moderates the bank’s policy, and induces the bank to follow a policy closer to the socially optimal one. Full transparency of the central bank’s intentions is generally socially beneficial, but frequently not in the interest of the bank. Somewhat paradoxically, direct observability of idiosyncratic central bank goals removes the moderating influence on the bank and leads to the worst equilibrium.
JEL Classification: E52, E58