Central banks have long been associated with secrecy. But over the last decade, this
has gradually changed, and transparency has now become one of the key features of
monetary policy. Writing in the latest issue of the Economic Journal, Petra Geraats
surveys the burgeoning research evidence of the value of central bank transparency in
controlling inflation.
The main findings are that:
?? The delegation of monetary policy to an independent and transparent central bank
has established itself as the new best practice.
?? Theoretical research suggests that two key benefits of transparency are the
reduction of private sector uncertainty and the improvement of incentives facing
monetary policy-makers.
?? Empirical evidence indicates that central bank transparency is relevant and
beneficial.
Transparency finds widespread support among central banks, not only in developed
countries, where it all started with New Zealand, Canada and the UK, but also in
emerging markets like Brazil. In fact, a recent survey shows that 74% of central banks
consider transparency a vital or very important component of their monetary policy
framework.
The theoretical literature suggests that transparency has two kinds of effects:
uncertainty effects and incentive effects.
First, transparency reduces ‘information asymmetries’ between the central bank and the
private sector, that is, differences in the information they possess about the state of the
economy and the prospects for monetary policy decisions. Some researchers have
suggested that the disclosure of additional information could lead to more variability of
private sector inflation expectations and negatively affect the achievement of stable
inflation. But central bankers do not seem to be concerned about this and cherish the
advantages of reduced private sector uncertainty.
Second, transparency could alter the incentives that central banks face as they attempt
to overcome information asymmetries and influence private sector perceptions. For
example, suppose a central bank is either responsible or inflationary, and that the
public uses policy actions and outcomes to assess the central bank's type. Then,
transparency would quickly expose an inflationary type and cause the private sector to
increase its inflation expectations. Since this negatively affects the central bank's policy
options, it tends to behave more responsibly. So, transparency results in lower inflation.
Furthermore, for independent central banks, the benefits of transparency include not
only a reduction of private sector uncertainty, but also greater flexibility to stabilise
economic disturbances, a reduction of output volatility and a closer alignment of central
bankers’ actions to socially optimal behaviour.
The empirical literature on transparency is still limited but has already yielded some
interesting results. In particular, it provides evidence that central banks possess private
information about the state of the economy that is relevant for monetary policy
decisions. This indicates that the issue of central bank transparency has practical
relevance. In addition, empirical evidence shows that transparency indeed has
beneficial effects as it reduces inflation and the financial markets' response to monetary
policy.
Finally, one might be tempted to believe that transparency is simply a consequence of
the delegation of monetary policy to independent central banks, which requires
accountability and therefore openness to safeguard democratic legitimacy. But it
appears that central bank transparency goes far beyond accountability requirements.
Furthermore, independence actually makes transparency beneficial since central banks
no longer have a motive to envelop themselves in secrecy to obtain insulation from
political pressures. This suggests that transparency has been adopted for economic
reasons. As a result, the prevailing paradigm in monetary policy is best characterised
as central bank independence and transparency.
ENDS
Notes for Editors: ‘Central Bank Transparency’ by Petra M Geraats is published in the
November 2002 issue of the Economic Journal.
Geraats is in the Faculty of Economics and Politics at the University of Cambridge.
For Further Information: contact Petra Geraats on 01223-335295 (email:
Petra.Geraats@econ.cam.ac.uk); or RES Media Consultant Romesh Vaitilingam on
0117-983-9770 or 07768-661095 (email: romesh@compuserve.com).