ACCOUNTABILITY AND TRANSPARENCY ABOUT CENTRAL BANK PREFERENCES FOR MODEL ROBUSTNESS
| Published date | 01 May 2010 |
| DOI | http://doi.org/10.1111/j.1467-9485.2010.00514.x |
| Author | Eleftherios Spyromitros,Meixing Dai |
| Date | 01 May 2010 |
ACCOUNTABILITY AND
TRANSPARENCY ABOUT CENTRAL
BANK PREFERENCES FOR MODEL
ROBUSTNESS
Meixing Dai
n
and Eleftherios Spyromitros
n
Abstract
Using a New Keynesian model subject to misspecifications, we examine the
accountability issue in a framework of delegation where government and private
agents are uncertain about the central bank’s preference for model robustness. We
show that, in the benchmark case of full transparency, the optimal inflation
targeting weight (or penalty) is decreasing with the preference for robustness.
Departing from the benchmark equilibrium, the central bank has then incentive to
be less transparent in order to reduce the optimal inflation targeting weight and
thus to become more independent vis-a
`-vis the government. We also find that
greater opacity will increase the sensibility of inflation and model misspecification
to the inflation shock but will decrease that of output-gap. Since macroeconomic
volatility could be increased or decreased under more opacity, there could exist in
some cases a trade-off between the level and the variability of inflation (and output
gap). Persistent inflation shocks could be associated with a higher inflation
targeting weight as well as a higher sensibility of inflation and output gap to the
inflation shock but a lower sensibility of model misspecification.
I Intro ductio n
The New-Keynesian approach to macroeconomic modelling is used extensively in
the monetary policy literature for almost a decade now. It has produced several
important insights in the analysis of monetary policy and is now co mmonly
applied to provide policy prescriptions (Clarida et al., 1999). Most of the studies
focus on specific topics and stay unconnected between them. In particular, recent
developments on optimal monetary policy in forward-looking models have
explored separately various notions of transparency and model robustness.
1
n
University of Strasbourg, France
1
Pioneered by Cukierman and Meltzer (1986), transparency issue has been examined in other
types of models both theoretically and empirically by Nolan and Schaling (1998), Faust and
Svensson (2001), Chortareas et al. (2002), Eijffinger and Geraats (2006), Demertzis and Hughes
Hallet (2007), among others.
Scottish Journal of Political Economy, Vol. 57, No. 2, May 2010
r2010 The Authors
Journal compilation r2010 Scottish Economic Society. Published by Blackwell Publishing Ltd,
9600 Garsington Road, Oxford, OX4 2DQ, UK and 350 Main St, Malden, MA, 02148, USA
212
Several studies examine issues related to monetary policy transparency in the
New-Keynesian framework, while assuming that the central bank knows the true
structure of the economy. Cukierman (2002) has demonstrated that it may be
rational for the central bank to de-emphasize a high flexibility parameter and
asymmetric preferences that might raise inflationary expectations. For Jens en
(2002), greater transparency about control errors means that policy has a larger
impact on future expectations and, via this channel, on current equilibrium
inflation. This leads the central bank to be less aggressive in its policy actions.
Eijffinger and Tesfaselassie (2007) find that, in the absence of uncertainty about the
central bank’s targets, advance disclosure of central bank’s private information on
future shocks impairs stabilization of current inflation and output.
To the difference of previous studies, Walsh (2003) introduces accountability
issues through an incentive scheme that puts a weight on the inflation target objec-
tive of the central bank. He has shown that the fundamental trade-off between
accountability and stabilization depends on the degree of transparency concerning
the central bank’s output-gap target, defined as the ability to monitor the central
bank’s performance.
Nevertheless, as any model, New-Keynesian models rest on a set of assumptions
that may or may not be good approximations of economies. Without the possibility
of having a complete description of reality, a policymaker is likely to prefer basing
policy on principles that are also valid if the assumptions on which the model is
founded differ from reality. In other words, policy prescriptions should be robust to
reasonable deviations from the benchmark model.
The literature on monetary policy robustness has been mainly developed into
two directions. The first one leads to what has been called robustly optimal
instrument rules (Giannoni and Woodford, 2003a, 2003b; Svensson and
Woodford, 2004). As these instrument rules do not depend on the specification
of the generating processes of the exogenous disturbances in the model, they are
therefore robust to misspecification in these processes. The second one, initiated
by Hansen and Sargent (2003, 2007), corresponds to robust control approach to
the decision problem of agents who face model uncertainty. In the sense of
Hansen and Sargent, robust monetary policies are designed to perform well in
worst-case scenarios. These policies arise as the equilibrium in a game between
the monetary authorities and an evil agent who chooses model misspecification
to make the authorities look as bad as possible. While these two approaches to
robust policies appear quite distinct, Walsh (2004) has demonstrated that both
approaches lead to exactly the same implicit instrument rule for the monetary
authorities in a standard forward-looking new Keynesian model.
2
The role of model robustness has been neglected until now in the literature on
transparency. In practice, central banks (especially inflation targeting central
banks) seem to publish plenty of analysis on their models and policy rules
2
A third approach to robustness considers what is called structured Knightian uncertainty.
Here, the uncertainty is assumed to be located in one or more specific parameters of the model
(Giannoni, 2002, 2007; Onatski and Stock, 2002). Another current of research studies the
robustness of a monetary policy rule across competing reference models. See for example
McCallum (1999), and Levin and Williams (2003).
ACCOUNTABILITY, MODEL ROBUSTNESS AND TRANSPARENCY 213
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Journal compilation r2010 Scottish Economic Society
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