Monetary policy in the presence of imperfect observability of the objectives of Central Bankers

Salsano, F. (2005) Monetary policy in the presence of imperfect observability of the objectives of Central Bankers. Working Paper. Birkbeck, University of London, London, UK.

Abstract

The paper presents a theoretical model for analysis of the imperfect observability of central bank preferences by the private sector on the decisions taken by the monetary authority, and therefore on the inflation rate. It examines in particular the connection which, in the presence of a time inconsistency problem, arises between the observability of the monetary institution's goals and its equilibrium strategies. The model yields innovative results from the technical and economic points of view. From the technical point of view, the study of equilibrium strategies in a simple signalling model allows derivation of the equilibrium outcomes of a monetary policy game already examined by D'Amato and Pistoresi (1996) and Sibert (2002), without the restrictions that those authors impose on the basis of the types of monetary institution. It is thus possible to identify the conditions on the model's parameters under which a pure separating equilibrium arises, and the conditions under which there instead exists a 'hybrid' equilibrium in which some types of Central Bankers adopt separating strategies (Vickers 1986; D'Amato and Pistoresi 1996; Sibert 2002) while others adopt pooling strategies similar to those studied by Backus and Dri¢ ll (1985). From an economic point of view, the paper shows a number of relations that arise, in equilibrium, between the degree of observability and transparency of the Central Banker's goals and the inflation rate set by the Central Banker.

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