Monetary policy transparency and inflation persistence in a small open economy

Dai, Meixing and Sidiropoulos, Moïse and Spyromitros, Eleftherios (2008): Monetary policy transparency and inflation persistence in a small open economy.

Abstract

Using a New Keynesian small open economy model, we examine the effects of central bank transparency on inflation persistence. We have found that more opacity could reinforce the effect of persistent shocks on the level and variability of endogenous variables if the difference between the interest elasticity of domestic goods demand and the degree of trade openness is sufficient large or sufficiently low, judging on structural parameters characterising the economy, the central bank preference and its initial degree of opacity. Our result implies that, under perfect capital mobility, a high degree of domestic financial development is a good reason for increasing the transparency.

• Item Type: MPRA Paper
• Language: English
• Keywords: Central bank’s transparency, open economy, inflation persistence, real exchange rate persistence
• Subjects: E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E58 - Central Banks and Their Policies; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F41 - Open Economy Macroeconomics

References

Andolfatto, David and Gomme, Paul (2003), “Monetary Policy Regimes and Beliefs,” International Economic Review, Vol. 44, No. 1, pp. 1-30.

Ball, L. (2000), “Near-Rationality and Inflation in Two Monetary Regimes,” NBER Working Paper 7988. Benati, Luca (2008), “Investigating inflation persistence across monetary regimes,” Quarterly Journal of Economics, vol. 123(3), pp. 1005-60.

Blanchard, O. J., and J. Gali (2007): “Real Wage Rigidities and the New Keynesian Model,” Journal of Money, Credit and Banking, 39(1), pp. 35—65.

Buiter, W. and I. Jewett (1989), “Staggered Wage Setting and Relative Wage Rigidities: Variations on a Theme of Taylor,” in: Willem Buiter (ed.), Macroeconomic Theory and Stabilization Policy. University of Michigan Press, Ann Arbor, pp. 183-99.

Calvo, G.A., O. Celasun and M. Kumhof (2001), “A Theory of Rational Inflationary Inertia,” in: P. Aghion, R. Frydman, J. Stiglitz and M. Woodford, eds., Knowledge, Information and Expectations in Modern Macroeconomics: In Honor of Edmund S. Phelps. Princeton: Princeton University Press.

Chortareas, G., D. Stasavage and G. Sterne (2002), “Does it pay to be transparent? International evidence from central bank forecasts,” Federal Reserve Bank of St. Louis Review 84, iss. 4, pp. 99-117.

Christiano, L., M. Eichenbaum and C. Evans (2005), “Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy,” Journal of Political Economy, vol. 113(1), pp. 1-45.

Clarida, R., J. Gali and M. Gertler (2001), “Optimal monetary policy in open versus closed economies,” American Economic Review Papers and Proceedings 91 (2), pp. 248-52.

Clarida, R., J. Gali and M. Gertler (1999), “The Science of Monetary Policy: A New Keynesian Perspective,” Journal of Economic Literature 37, pp. 1661-707.

Corsetti, Giancarlo, Luca Dedola and Sylvain Leduc (2008), “High exchange-rate volatility and low pass-through,” Journal of Monetary Economics 55(6), pp. 1113-28.

Devereux, Michael B. and Charles Engel (2002), “Exchange rate pass-through, exchange rate volatility, and exchange rate disconnect,” Journal of Monetary Economics, Vol. 49, Issue 5, pp. 913-40.

Dillén, Hans and Johnny Nilsson (1998), “Transparency, un certainty and monetary policy,” Benjamin Hunt and Adrian Orr (Editors), Monetary policy under uncertainty, Proceedings of a workshop held at the Reserve Bank of New Zealand, June: pp. 204-22.

Dincer, N. Nergiz and Barry Eichengreen (2007), “Central bank transparency: where, why, and with what effects?” NBER Working Paper 13003.

Dittmar, Robert D., William T. Gavin and Finn E. Kydland (2005), “Inflation Persistence and Flexible Prices,” International Economic Review, vol. 46(1), pp. 245-61.

Dornbusch, R. (1987), “Exchange rates and prices,” American Economic Review 77, pp. 93-106.

Krugman, P. (1987), “Pricing to market when the exchange rate changes,” In: Arndt, S., Richardson, J. (Eds.), Real-Financial Linkages among Open Economies. MIT Press, Cambridge.

Eijffinger, S.C.W. and P.M. Geraats (2006), “How transparent are central banks?” European Journal of Political Economy 22, pp. 1–21.

Eijffinger, Sylvester C.W., Lex Hoogduin and Carin A.B. van der Cruijsen (2008), “Optimal Central Bank Transparency,” CEPR DP6889.

Erceg, C. and A. Levin (2003), “Imperfect Credibility and Inflation Persistence,” Journal of Monetary Economics, Vol. 50, Issue 4, pp. 915-44.

Fuhrer, J. (2000), “Habit Formation in Consumption and its Implications for Monetary Policy Models,” American Economic Review 90, pp. 367-90.

Fuhrer, J. and G. Moore (1995), “Inflation Persistence,” Quarterly Journal of Economics 110, pp. 127-59.

Galí, J. and T. Monacelli (2005), “Monetary policy and exchange rate volatility in a small open economy,” Review of Economic Studies, 2005, vol. 72, issue 3, pp. 707-34.

Gaspar, Vítor, Frank Smets and David Vestin (2006), “Adaptive learning, persistence, and optimal monetary policy,” ECB Working Paper Series No. 644.

Geraats, Petra (2002), “Central Bank Transparency,” The Economic Journal 112, pp. 532-65.

Goldberg, P. and M. Knetter (1997), “Goods prices and exchange rates: what have we learned?” Journal of Economic Literature 35, pp. 1243-72.

Goodfriend, M. and R.G. King (1997), “The new neoclassical synthesis and the role of monetary policy,” NBER Macroeconomics Annual, pp. 231-83.

Goodfriend, M. and R. King (2001), “The Case for Price Stability,” NBER Working Paper 8423.

Huh, C., Lansing, K. (2000), “Expectations, credibility and disinflation in a small macroeconomic model,” Journal of Economics and Business 51, pp. 51–86.

Ireland, Peter N. (2000), “Expectations, Credibility, and Time-Consistent Monetary Policy,” Macroeconomic Dynamics 4, pp. 448-66.

Ireland, Peter N. (2004), “A Method for Taking Models to the Data,” Journal of Economic Dynamics & Control 28, pp. 1205-26.

Kenneth N. Kuttner and Adam S. Posen (2001), “Inflation, Monetary Transparency, and G3 Exchange Rate Volatility,” in Balling, Hennessy and Hochreiter (eds.), Adapting to Financial Globalisation, London: Routledge.

Krugman, Paul R. (1987), “Pricing-to-MarketWhen the Exchange Rate Changes,” in S.W. Arndt and J.D. Richardson, eds., Real Financial Linkages Among Open Economies. Cambridge Mass: MIT Press.

Leitemo, Kai and Ulf Söderström (2008), “Robust Monetary Policy in a Small Open Economy,” Journal of Economic Dynamics and Control, vol. 32(10), pp. 3218-52.

Mankiw, N.G. and R. Reis (2001), “Sticky Information Versus Sticky Prices: A Proposal to Replace the New Keynesian Phillips Curve,” NBER Working Paper 8290.

McCallum, Bennet T. (1983), “On non-uniqueness in rational expectations models: An attempt at perspective,” Journal of Monetary Economics, 11(2), pp. 139-68.

Mennon, J. (1995), “Exchange rate pass-through,” Journal of Economic Surveys 9 (2), pp. 197-231.

Nelson, E. (1998), “Sluggish Inflation and Optimising Models of the Business Cycle,” Journal of Monetary Economics 42, pp. 303-22.

Pivetta, F. and R. Reis (2007), “The Persistence of Inflation in the United States,” Journal of Economic Dynamics & Control 31, pp. 1326-58.

Roberts, J. (1998), “Inflation Expectations and the Transmission of Monetary Policy,” Finance and Economics Discussion Paper no. 98-43. Washington, D.C.: Board of Governors of the Federal Reserve System.

Rotemberg, J.J. and M. Woodford (1997), “An optimization-based econometric framework for the evaluation of monetary policy,” in B.S. Bernanke and J.J. Rotemberg (eds.), NBER Macroeconomic Annual, The MIT Press.

Sargent, T. (1999), The Conquest of American Inflation. Princeton University Press.

Sims, C. (2001), “Implications of Rational Inattention,” Manuscript, Princeton University.

Smets, Frank and Raf Wouters (2002), “Openness, imperfect exchange rate pass-through and monetary policy,” Journal of Monetary Economics, Vol. 49, Issue 5, pp. 947-81.

Steinsson, J. (2003), “Optimal Monetary Policy in an Economy with Inflation Persistence,” Journal of Monetary Economics 50, pp. 1425-56.

Stock, J. (2001), “Comment on Evolving Post-World War II U.S. Inflation Dynamics,” NBER Macroeconomics Annual 2001, pp. 379-87.

Svensson, Lars E.O. (2002), “Inflation Targeting: Should It Be Modeled as an Instrument Rule or a Targeting Rule?” European Economic Review 46, pp. 771-80.

Taylor, J.B. (1983), “Union wage settlements during a disinflation,” American Economic Review 73, pp. 981–83.

Van der Cruijsen, Carin and Maria Demertzis (2007), “The impact of central bank transparency on inflation expectations,” European Journal of Political Economy, vol. 23, issue 1, pp. 51-66.

Westelius, N.J. (2005), “Discretionary monetary policy and inflation persistence,” Journal of Monetary Economics 52, pp. 477-96.

Woodford, M. (2001), “Imperfect Common Knowledge and the Effects of Monetary Policy,” NBER Working Paper 8673.