Bayesian Nash equilibria and monetary policy
economic models which the policy is derived from. This approach can also address credibility issues of the central bank, as market participants are given just enough insight to verify the central bank’s actions through observable outcomes without needing to grasp the underlying economic reasoning. This controlled communication strategy ensures the central bank remains flexible to adjust its response without having to re-align public expectations significantly. The specialized audience that received more detailed information would understand the policy change; however, a general public lacking economic knowledge may not, and could overreact.
Conclusion
Through a Bayesian game-theoretic analysis of the relationship between inflation expectations and central banking transparency, I have found the optimal level of transparency to be 9.7/15. This result is derived from empirical evidence from the Bank of England and the Federal Reserve. At this level of transparency, the public’s inflation expectations are stabil ize d and align with the central bank’s aims. This result avoids possible overreliance and public confusion about the central bank’s communication, but still provides generous information that allows market participants to calibrate their inflation expectations to the central bank’s target. By having stabil ized inflation expectations in line with the bank’s target or the current rate of inflation, the possibility of an inflation expectations trap is avoided as the central bank does not have to intervene in the economy to align the inflation rate with expectations. This ensures the central bank can remain committed to its present strategy, which stabilizes the economy (Albanesi et al., 2003) and improves their credibility. Thus, I have developed a policy recommendation that uses two strategies simultaneously to communicate monetary policy with optimal transparency. The central bank should communicate the full policy rule to a specialized audience who understand the reasoning, and only communicate the conditions that the policy is derived from to the general public. This approach gives the general public enough information to make informed inflation expectations without overwhelming them with the complex economic calculus used to make that decision. This proposed strategy will ensure that expectations are stabilized, thereby mitigating the possibility of an inflation expectations trap. The result is a stabilized economy and a more credible central bank.
Bibliography
Primary Sources Jones, David. (2024) ‘EPQ Interview’. Shirgaokar, Nikhil. (2024) ‘EPQ Survey’.
Secondary Sources Albanesi, S. et al. (2003) ‘Expectation Traps and Monetary Policy’, The Review of Economic Studies , 70.4: 715 – 741. Available at: https://www.jstor.org/stable/3648621 (Accessed: 3/01/24) Albrizio, S. and Bluedorn, J. (2023) How Managing Inflation Expectations Can Help Economies Achieve a Softer Landing . Available at: https://www.imf.org/en/Blogs/Articles/2023/10/04/howmanaging-inflation-expectations-can- help-economies-achieve-a-softer-landing (Accessed: 4 February 2024) Ali Hussein Samadi et al. (2018) ‘Quantum Barro–Gordon game in monetary economics’, Physica A: Statistical Mechanics and its Applications 489: 94 – 101. Available at:
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