Bayesian Nash equilibria and monetary policy
figure 7 & 8, respectively. The use of empirical BoE and Fed data validates these results, which support the theoretical notion that too much or too little transparency negatively impacts expectations.
Figures 7 & 8: Federal Reserve simulation, Bank of England simulation
Equilibrium analysis
This study concludes that the optimal transparency level for the Federal Reserve and the Bank of England is 9.675 and 9.795, respectively, on the Eijffinger-Geraats transparency index (2002). This result ensures that the central bank communicates its policies clearly while still conveying the necessary level of complexity needed for the public to understand its reasoning and goals (Issing, 2005). This result also mitigates the risk of being overly transparent and causing information overload/confusion (Ehrmann and Fratzscher, 2005) and over-reliance (Tversky and Kahneman, 1974) on central bank communications. The optimal level of transparency is not directly in the middle of these two extremes, as the issue of uncertainty and creating forecasts is more pressing than consumers becoming overwhelmed, which only happens at extreme levels of transparency (Cruijsen et al., 2010). Changing consumer behaviour is the best solution to mitigate inflation expectations traps. Behavioural economics creates the notion that decision making is irrational and emotional. An aspect transparency can combat is availability bias. When making a decision, it is often whatever you can remember first that forms that choice (Mamede S et al., 2010). For example, an anti-smoking advert seen in the morning comes to mind immediately when a consumer thinks about buying cigarettes. Being at the first spot in p eople’s minds for the central bank is controlled by its transparency, how much information they communicate to the public and with what complexity. In theory, using our optimal level of transparency, rather than using irrational information built from their biases to form inflation expectations, the public will think of information recently released by the Bank of England. Obviously, this would not happen in the real world in all cases, but it would certainly influence some. Given this figure of optimal transparency, the central bank needs to create corresponding policies that influence behaviour.
Policy recommendations
Given an optimal transparency level of around 9.7, I have devised two policy recommendations which fit this level, stabilize expectations and mitigate expectations traps. They are designed to work simultaneously by targeting different segments of the population. These policy recommendations have been analysed by Eusepi and Preston (2010), who have proven that each ‘ ensure consistency between
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