Transparency, the Opacity Bias, and Optimal Flexible Ination Targeting

In this paper, I revisit an old question …rst studied by Rogo¤ (1984) –should central banks pursue objectives that di¤er systematically from social welfare? I investigate how the answer to this question is affected by the degree of transparency that characterizes monetary policy. When the policy regime is one of discretion and the central bank is opaque, changes in the policy interest rate have informational e¤ects that distort the central bank’s incentives and generate policy biases (Geraats 2002). Directing the central bank to place more weight on in‡ation stablization, i.e., to implement a less ‡exible in‡ation targeting policy, can o¤set this distortion and lead to lower social loss. In contrast, the objectives of a transparent central bank should not di¤er from those of society. However, outcomes under transparency may be dominated by those produced by an opaque and conservative (i.e., less ‡exible) central bank. JEL Classi…cation Numbers: E52, E58