Bayesian Nash equilibria and monetary policy
private forecasts and monetary policy strategy ’ . These policies resolve the Taylor principle, where ‘ the nominal interest rate should be raised more than point-for-point when inflation rises, so that the real interest rate increases ’ (Nikolsko-Rzhevskyy et al., 2019), and therefore anchor expectations.
Strategy one: the full policy details
The first strategy is for the central bank to communicate full policy details to a specialized audience. Communicating the precise details of the policy rule and explaining the mechanisms of response provides financial analysts and institutional investors with the nuanced information required to predict the central bank's actions accurately. This avoids overwhelming the general public with excessive detail. This approach is especially effective in environments characterized by significant economic uncertainty, where these specialized stakeholders benefit from clear guidance on the expected monetary policy response. In Eusepi and Preston’s analysis, it was revealed that fully communicating the policy rule to an informed audience helps maintain economic stability by enabling these participants to refine their expectations continuously based on the most recent information, despite having incomplete knowledge about the broader economic environment. When these informed agents understand the central bank’s reasoning for reacting to differen t economic conditions, they can more accurately predict future monetary policy actions, leading to more stable and reliable financial market expectations. The specialized audience can communicate the simplified policy action to the public. For example, when the central bank clearly communicates why they are responding to a recent uptick in inflation by adjusting interest rates, these specialized participants, understanding that an increase in inflation leads to a corresponding rise in nominal interest rates, anticipate an adjustment in real interest rates accordingly. This anticipation leads to strategic changes in investment behaviours and financial advice, which collectively help to reduce the initial surge in inflation and the associated rise in broader market expectations, as they trust and spread the central bank’s commitment to stabil izing inflation. By fully explaining the policy rule to a specialized audience, the optimal transparency level of 9.7/15 is fulfilled, providing precise and actionable information that surpasses general communication needs (7.5/15). However, this strategy also carefully omits certain operational specifics, sharing just enough to ensure comprehension without compromising the central bank's ability to adapt its policies as economic conditions evolve. This selective disclosure maximizes the use of the remaining level of transparency (>9.7/15) to preserve strategic flexibility and prevent destabilization due to premature or misinformed reactions by the general market.
Strategy two: the conditioned variables
The second strategy validated by Eusepi and Preston is to only communicate variables that the policy decisions are conditioned for to the general public. The communication omits the exact relationship between these variables, such as nominal interest rates and the output gap. This selective disclosure provides the remaining market participants with the necessary information needed to anticipate changes in monetary policy and to form stable expectations, while intentionally leaving out detailed coefficients and mathematical formulations used to derive policy changes. This benefits environments where too much information could lead to excessive speculation, misinterpretation, and confusion (Ehrmann and Fratzscher, 2005) by agents who lack the technical expertise to understand complex
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