Information Frictions, Central Bank Communication, and Monetary Policy

• Applicant: Professor Donghai Zhang, Ph.D.
• Subject Area: Economic Policy, Applied Economics
• Term: from 2022 to 2024
• Project identifier: Deutsche Forschungsgemeinschaft (DFG) - Project number 495072044

Economic conditions, such as the natural level of output and the natural unemployment rate, are not observable. Central banks, e.g., the European Central Bank (ECB) and the Federal Reserve bank (Fed) in the United States, attribute abundant resources to monitor economic activities. Thus, they might have superior information regarding the state of the economy. In this project, we address the following questions. Should the central bank reveal its private information about economic conditions? How does asymmetric information between the central bank and private market affect the transmission of monetary policy? How do information frictions affect the design of optimal monetary policy? Answers to these questions are relevant within the academic circle and important for policymakers. The proposed research project consists of three papers that aim to answer these questions separately. The conventional wisdom views the increased central bank transparency as optimal. In the first paper, we propose to study the optimal central bank communication based on a framework with dispersed beliefs and nominal rigidity. We argue that more transparency does not necessarily improve welfare due to nominal rigidities. Our model allows quantifying the welfare loss/gain of central bank communication. Once the project is completed, we will provide a policy recommendation whether the Fed, the Bank of England, or the ECB have released too much information to the market. In the second paper, we study the effects of monetary policy in a model with asymmetric information between the central bank and the private market. Moreover, we introduce ambiguous signals and ambiguity-averse agents. The ambiguous signaling channel of monetary policy emerges in such a framework. In the third paper, we study the optimal monetary policy in a model with dispersed beliefs, nominal rigidity, and endogenous learning from price.

• DFG Programme: Research Grants
• International Connection: China
• Cooperation Partners: Professor Dr. Shengliang Ou; Professor Dr. Renbin Zhang