NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Constrained Discretion and Central Bank Transparency

Francesco Bianchi, Leonardo Melosi

NBER Working Paper No. 20566
Issued in October 2014
NBER Program(s):   ME

We develop and estimate a general equilibrium model in which monetary policy can deviate from active inflation stabilization and agents face uncertainty about the nature of these deviations. When observing a deviation, agents conduct Bayesian learning to infer its likely duration. Under constrained discretion, only short deviations occur: Agents are confident about a prompt return to the active regime, macroeconomic uncertainty is low, welfare is high. However, if a deviation persists, agents' beliefs start drifting, uncertainty accelerates, and welfare declines. If the duration of the deviations is announced, uncertainty follows a reverse path. When estimated to match past U.S. experience, our model suggests that transparency lowers uncertainty and increases welfare.

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Document Object Identifier (DOI): 10.3386/w20566

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