No 78. Why Central Banks Announce their Objectives: Monetary Policy with Discretionary Signalling

Abstract

This paper analyzes the use of announcements of objectives or intentions, announcements which are common in implementation of monetary policy. To analyze such announcements, this paper uses a model in which there is asymmetric information over the central bank’s objectives. This informational asymmetry is represented by a stochastic inflation target, upon which only the central bank can condition its actions. Thus, the scope is set for signalling, and the use of announcements can be seen as a way for a central bank to signal its type. This paper assumes that a central bank can signal at its own discretion and shows that while central banks with high inflation targets never use announcements, central banks with low inflation targets occasionally, but not always, will choose to reveal their private information through an announcement. At first finding is that, contrary to what a cheap-talk equilibrium suggests, the announcements may be more precise the larger the central bank’s news. Moreover, this paper shows that the frequency of announcements is unambiguously increasing in the magnitude of the central bank’s news, something that goes well in line with what is typically found in actual implementation of monetary policy.