Are contemporary central banks transparent about economic models and objectives and what difference does it make?
In: Discussion paper 2001,5
This paper documents the opaqueness of central banks about the economic models they use to choose policy but argues that this is largely due to the lack of consensus about the correct model of the economy within the economic profession. The latter is illustrated by contrasting three currently popular models of the transmission mechanism. Although the inflation targets of Western central banks are currently quite clear they tend to be hazy about their output targets and about whether they are strictor flexible inflation targeters (in Svensson's (1997) sense), and in the second case, how flexible. They are remarkably silent about the shape of their loss function in the entire range of output gaps. The second part of the paper first reviews the case for believing that at least some central banks are, given inflation, more averse to negative than to positive output gaps and then investigates the consequences of this asymmetry for average inflation. It is shown, for both an expactations augmented Phillips curve as well as for a New -Keynesian transmission mechanism, that in the presence of uncertainty about the upcoming state of the economy flexible inflation targeters with assymetric objectives induce an onflation bias even if their output target is the potential level. Furtehrmore the inflationary tendencies of policymakers who believe in sticky prices are stronger than of those who do not. But, provided prices are really in sticky, the economy is non neutral even in the long run, and the policies of the former also induce a higher level of output. The consequences of transparency about those mechanisms for credibility are evaluated.