Monetary policy transparency, inflation and the sacrifice ratio

Abstract

We examine how inflation and the costs associated with disinflation episodes are related to monetary policy transparency. We develop a simple model that demonstrates how transparency may result in lower inflation. Our empirical results show that in general, transparency may be associated with lower inflation across a broad range of countries and frameworks. In addition, the output costs of disinflation, as measured by the sacrifice ratio, are negatively related to the degree of monetary policy transparency. The capacity of the central bank to limit the monetary financing of government deficits also has an inflation-reducing effect. Considering transparency as a possible determinant of cross-country differences in the costs of disinflation represents a new contribution to the literature, especially given the failure of previous empirical research to find a robust negative relationship between other aspects of the central bank's institutional design and the sacrifice ratio.

Forward Guidance Through Interest Rate Projections: Does It Work?

“…They find some evidence, although weak, of improved forecast accuracy over relatively short forecast horizons in New Zealand, Norway, and 3 The main bulk of empirical studies on forward guidance have focused on the merits of transparency in terms of having an explicit inflation target, verbal communication, voting records etc. Chortareas et al (2002), Cecchetti et al (2002), andGeraats et al (2006) find that transparency makes monetary policy more credible and helps achieving the ultimate policy objectives. There is also a number of studies on the predictability of monetary policy.…”

Central Bank Transparency and Financial Market Expectations: The Case of Emerging Markets

“…In addition, Chortareas et al (2002b) examine the influence of transparency in forecasting and decision-making on the costs of disinflation. The sacrifice ratio is negatively related to transparency in forecasting but not to transparency in the decision-making process.…”

Does monetary policy transparency reduce disinflation costs?

“…In two earlier papers Sterne, 2002b andStasavage, 2001) we reported sacrifice ratio estimates based on observation of disinflation periods (following Ball, 1994) and based on time-series estimates of short-run Phillips curves (following Hutchinson and Walsh, 1998). In this paper we estimate sacrifice ratios based on short-run Phillips curves, and we improve on our earlier results in three ways.…”

“…This is also a Guttman scale, in this case designed to measure the extent to which information about central bank decisions is made public. See Chortareas, Stasavage, and Sterne (2002b) for a more detailed description.…”