Transparency of Monetary Policy in a Small Open Economy
Transparency of monetary policy has recently received a great deal of attention in the economic literature. Yet there has been no analysis of the open economy case. This paper investigates the subject and provides some interesting theoretical results. In particular, I show that transparency is especially beneficial for central banks in large economies or that enjoy low credibility. Setting a target for inflation and making it public leads to smaller losses to the central bank and, in a cashless economy, higher welfare. Moreover, the model suggests that central banks that move from regimes of intermediate transparency (when communication does convey some information, although fuzzy) to a regime of higher openness (like inflation targeting) should be more successful in stabilizing both the output gap and the rate of inflation. Finally, transparency is also beneficial for exchange rate stability, particularly for central banks that lack credibility. These results are consistent with the empirical evidence that higher transparency leads to lower price and exchange rate volatility.