Discussion Paper Series 2009-E-5

Central Bank Communication and Multiple Equilibria

Kozo Ueda

We construct a simple model in which a central bank communicates with money market traders. We demonstrate that there exist multiple equilibria. In one equilibrium, traders truthfully reveal their own information, and by learning this, the central bank can make better forecasts. Another equilibrium is a "dog-chasing-its-tail" equilibrium in Blinder (1998). Traders mimic the central bank's forecast, so the central bank simply observes its own forecast from traders. The latter equilibrium is socially worse in that inflation variability becomes larger. We also demonstrate that too high transparency of central banks is bad because it yields the "dog-chasing-its-tail" equilibrium, and that central banks should conduct continuous monitoring or emphasize that their forecasts are conditional because doing so eliminates the "dog-chasing-its-tail" equilibrium.

Keywords: Transparency; disclosure; coordination

Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.

Copyright © 2009 Bank of Japan All Rights Reserved.

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