Does Central Bank transparency impact financial markets? A cross-country econometric analysis

Southern Economic Journal, Jan, 2007 by Marc Tomljanovich

This study adds to the existing literature in the following ways. First, in contrast to many previous empirical studies involving transparency, such as Chortareas, Stasavage, and Sterne (2002) and Cecchetti and Krause (2002), we examine how the move to greater transparency has influenced financial market factors rather than macroeconomic factors. More specifically, we focus on how increased central bank openness may impact the expectations hypothesis, and thus the term structure of interest rates. Understanding the term structure is of prime importance to central banks, since they can most directly influence short-term rates, yet aggregate demand depends chiefly on long-term interest rates. The effectiveness of the monetary transmission mechanism, then, may be linked to the degree of transparency chosen by a central bank. Second, virtually all other studies, including Thornton (1996), Muller and Zellmer (1999), Rafferty and Tomljanovich (2002), and Coppel and Connolly (2003) analyze a single central bank. Instead, we directly compare central bank policies and financial effects in seven developed countries as a means of controlling for changing national and global conditions across the time span. This cross-country methodology also allows for a comparison between central banks that have moved towards greater disclosure and those central banks that have remained opaque. Third, we attempt to disentangle the effects of changing transparency from other central bank procedural changes, such as independence from the national government or implementing an inflation targeting regime.

The paper proceeds as follows. Section 2 lays out the definition of central bank transparency and the economic and political issues surrounding transparency, and summarizes the literature. Section 3 describes the data and models used. Section 4 outlines the main results. Finally, section 5 offers policy recommendations and concludes.

2. Background and Related Literature

Defining Transparency

Complete transparency simply means that the central bank and the public have access to the same information, incomplete or uncertain though it may be, when making economic decisions. (3) Since the central bank generally has access to information first, transparency then suggests that the central bank "accurately" passes information on to other agents. (4) "Accurately" is difficult to define in practical terms. Though many economists believe in the "more is better" creed, a distinction needs to be made here between accuracy and clarity due to the sheer amount of quantitative and qualitative information a central bank collects in the process of policy implementation. One possibility open to a central bank in a move toward greater transparency is to flood the public with all such internally gathered information (such as, for example, on the central bank's website). The obvious drawback to this approach is that the time and expertise needed by members of the public to sift through the information renders timely decision-making nearly impossible. Therefore, greater transparency by this benchmark may in fact hinder economic decisions and thus reduce social welfare.