Monetary Policy under Imperfect Common Knowledge: Theory and Experimental Evidence
Final Report Abstract
The traditional literature which questions the validity of transparency has the disadvantage of underestimating the impact of informational policy on higher order beliefs and coordination. Taking into account the dual role of information (dissolution of fundamental and strategic uncertainty) can bring a fresh look at the potential limits of transparency. The theoretical innovations of the program within this literature focus on new information structures on the one hand and the application of coordination games with heterogeneous information in monetary policy on the other. First, in this program, we consider the possibility of limited degree of publicity and multiple public signals. These two modes of information dissemination avoid common knowledge by generating limited higher order beliefs and thus reduce the potentially destabilizing effects of over-reaction to announcements. This literature based on coordination games with heterogeneous information considers communication as the only task of the central bank and ignores the fact that communication is usually associated with action. In a series of articles, we focus on the connection between optimal monetary policy and communication strategy by introducing the signaling role of monetary instrument in a more standard monetary policy framework. In general, we highlight the fact that the optimal monetary policy of the central bank is a function of its communication strategy. From an empirical point of view, we test the theoretical implications of the previous models by using experimental economics. We sought to account for over-reaction phenomenon and experimentally explore the tools to reduce over-reaction. Cornand and Heinemann (2011) show that participants in the experiment gave greater weight to the public signal than to their private signal, but gave it a lower weight than predicted by theory. We explain this result by the limited degree of higher-order beliefs that participants can achieve in practice. Therefore, public information is less damaging in terms of welfare than what theory predicts, and private information can cause problems, even if it is intrinsically irrelevant to make a decision. In a closely related framework Cornand and Baeriswyl (2011) study how partial publicity and partial transparency can reduce agents’ over-reaction to announcements. We show that these two alternative tools are identically effective. The paper of Daniels (2009) precisely inserts limited higher order beliefs in a theoretical model and gives their implications for monetary policy. He examines the implications for the dissemination of information and shows that this new model can account for a number of stylized facts.
Publications
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(2008), "Can Central Banks Talk Too Much?" VOX: Research-based policy analysis and commentary from leading economists, 27 May 2008
Cornand, Camille, and Frank Heinemann
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(2008), "La politique Monetaire en Information Heterogene", Revue Française d'Economie, vol. XXIII, n°l, p. 117-163
Baeriswyl, Romain, and Camille Cornand
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(2008), "Optimal Degree of Public Information Dissemination", The Economic Journal, vol. 118, p. 718-742
Cornand, Camille, and Frank Heinemann
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(2009), "Speculative Attacks with Multiple Sources of Public Information", Scandinavian Journal of Economics, vol. 111, n° 1, p. 73-101
Comand, Camille, and Frank Heinemann
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(2010), "Optimal Monetary Policy in Response to Supply Inflation: the Impact of Central Bank Communication", Internationa Journal of Central Banking, vol. 6, n°2, p. 31-52
Baeriswyl, Romain, and Camille Cornand
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(2010), "The Signaling Role of Policy Actions", Journal of Monetary Economics, vol. 57, n°6, p. 682-695
Baeriswyl, Romain, and Camille Cornand
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(2011), "Transparency and Monetary Policy Effectiveness ", Annals of Economics and Statistics {Annales d'Economie et de Statistique), n° 103-104,p. 165-184
Baeriswyl, Romain, and Camille Cornand
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(2011), "Currency Crises with the Threat of an Interest Rate Defence", Journal of International Economics, vol. 85, p. 14-24
Daniels, Tijmen R., Henk Jager, and Franc Klaassen
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(2012), "Every Symmetric 3x3 Global Game of Strategic Complementarities is Noise Independent", Journal of Mathematical Economics, vol. 47, p. 749-754
Basteck, Christian, and Tijmen R. Daniels
