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

Southern Economic Journal, Jan, 2007 by Marc Tomljanovich

Several theoretical papers examine conditions under which increased central bank transparency may not lead to socially optimal outcomes. Cukierman and Metzler (1986) argue that changing objectives between fostering economic growth and preventing inflation on the part of the central bank can lead to situations in which informational opacity is preferred. They establish a multi-period model that demonstrates ambiguity is preferred to transparency by a central authority with frequently changing political objectives and a high enough rate of time preference. Ambiguity provides the central authority with greater control over the timing of monetary shocks, and thus over its objectives, though the presence of more frequent shocks may lead to less policy credibility with citizens. Note that the central bank having multiple objectives is essential to the welfare-enhancing scenario that emerges from refusing to divulge information to the public. Hence, for central banks that pursue a single policy goal, in particular inflation targeting, there is no economic rationale not to be transparent. Furthermore, central banks have moved away from trying to catch markets off-guard to boost output temporarily (see Issing 1999 and Blinder et al. 2001). Faust and Svensson (2002) build upon their framework by allowing the central bank to choose separately the optimal degrees of control and transparency. They show that sufficiently patient central banks with a low enough inflation bias will always choose to have the minimum transparency possible. Dotsey (1987) and Rudin (1988) both argue that transparency should increase unconditional volatility, since clearer, more frequent information signals will cause asset prices to fluctuate more frequently to "news." And Geraats (2001) explains that economic transparency (5) may be undesirable in the presence of a conservative central banker that is subject to political pressures.

However, other authors have argued for greater transparency by central banks. Goodfriend (1986) systemically dismantles each of the Fed's five principle arguments for maintaining policy secrecy, and comes to the conclusion that there are very few circumstances under which opacity is desirable for a central bank. Blinder (1998) argues that a nation's central bank should explain its actions to the people, so as to remove the mystery behind the decisionmaking process. Though it would make bank officials and the entire process more accountable to the public, greater openness is a fundamental part of a democracy. If the bank cannot provide a clear explanation of a decision, then the decision may not be a good one. Blinder (1998) and Blinder et al. (2001) assert that more open public disclosure of central bank policies may enhance the efficiency of financial markets. First, greater information about how a central bank makes policy decisions would curtail excessive speculation. Second, clearer decision rules on the part of the central bank would help to reduce the volatility of markets, and thus enhance the predictability of future movements of financial assets.