Central Bank Communication and Expectations Stabilization

Abstract

The value of communication is analyzed in a model in which agents' expectations need not be consistent with central bank policy. Without communication, the Taylor principle is not sufficient for macroeconomic stability: divergent learning dynamics are possible. Three communication strategies are contemplated to ensure consistency between private forecasts and monetary policy strategy: communicating the precise details of policy; communicating only the variables on which policy decisions are conditioned; and communicating the inflation target. The former strategies restore the Taylor principle as a sufficient condition for anchoring expectations. The latter strategy, in general, fails to protect against expectations-driven fluctuations. (JEL E32, E43, E52, E58). Show more