tailieunhanh - HEI Working Paper No: 19/2007 : Interest Rate Signals and Central Bank Transparency

Interest rate exposure is generally described as the risk of a reduction in a pro- jected or anticipated measure of net interest income (target measure) resulting from changes in market interest rates. 1 Yet from a practical perspective such a defi nition is somewhat fl awed, as the use of an anticipated (or projected) mea- sure of net interest income is fraught with risks. Any inappropriate assum ption in the projection phase will produce an inaccurate target measure and, conse- quently, result in an inaccurate assessment of interest rate risk. In a more useful way, interest rate exposure could be defi ned as the. | Graduate Institute of International Studies I Geneva Economics HEI Working Paper No 19 2007 Interest Rate Signals and Central Bank Transparency Pierre Gosselin Aileen Lotz Charles Wyplosz Graduate Institute for International Studies Geneva Abstract The present paper extends the literature on central bank transparency that relies on information heterogeneity among private agents in four directions. First it adds the interest rate to the list of signals that the central bank can reveal. Second it allows for more than one economic fundamental. Third it extends the range of uncertainties that matter. So far the literature has focused on uncertainty about the economic fundamentals assumed to be estimated with known precision we also allow for uncertainty about precision. Fourth it derives results that are general in the sense that they do not depend on any particular social welfare criterion. Each extension sheds new light on the role of central bank transparency. While uncertainty about the fundamentals results in the now familiar common knowledge effect uncertainty about information precision creates a fog effect which reduces the quality of decision taken by the central bank and the private sector. In the absence of the fog effect full transparency is generally not desirable because it deprives the central bank from the ability to optimally manipulate private sector expectations. When the central bank fog is large full transparency is usually the best communication strategy even when the private sector fog is large. We also find that it is usually desirable for the central bank to divulge some information even if it is erroneous. Acknowledgments The paper has benefited from comments received at ISOM seminar in Istanbul and from David Archer Charlie Bean Alex Cukierman Andrew Fillardo Hans Genberg Petra Gerlach Hyun Song Shin Nicolas Tarashev and Michael Woodford. All errors are ours. The rights reserved. No part of this paper may be reproduced without the

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