Alex Cukierman

A Theory of Ambiguity, Credibility, and Inflation under Discretion and Asymmetric Information

This paper develops a positive theory of credibility, ambiguity, and inflation under discretion and asymmetric information. The monetary policymaker maximizes his own (politically motivated) objective function that is positively related to economic stimulation through monetary surprises and negatively related to monetary growth. The relative importance he assigns to each target shifts stochastically through time. His current preference trade-off is known to him but not to the public. When choosing the (state contingent) path of money growth for the present and the future, the policymaker compares the benefits from current stimulation with the costs associated with higher future inflation expectations. Current monetary growth conveys information to the public about future money growth because there is persistence in the policymakers objectives. Although expectations are rational, information is imperfect because monetary control procedures are imprecise. As a result the public cannot correctly distinguish persistent changes of emphasis on different policy objectives from transitory monetary control errors. The public becomes aware of changes gradually by observing past monetary growth. Credibility is defined in terms of the speed with which the public recognizes changes in the objectives of the policymaker. Credibility is lower the noisier monetary control and the more stable the objectives of the policymaker. Looser monetary control and a higher degree of time preference on the part of the policymaker induce him to produce higher and more variable monetary growth. When the policymaker is free to determine the accuracy of monetary control he does not always choose the most effective control available in spite of the fact that monetary surprises always have an expected value of zero. The reason is that ambiguous control procedures enable the policymaker to generate positive surprises when he cares more than on average about economic stimulation. He leaves the inevitable negative surprises for periods in which he cares more about inflation prevention. This result provides an explanation for the Feds preference for ambiguity, recently documented by Goodfriend (1986). The policymaker is more likely to pick more ambiguous control procedures the more uncertain his objectives and the higher his time preference. The paper also provides a theoretical underpinning for the well documented crosscountry positive correlation between the level and the variability of inflation.

Central Bank Reform, Liberalization and Inflation in Transition Economies - An International Perspective

This Paper develops extensive new indices of legal independence (Central Bank Independence, or CBI) for new central banks in 26 former socialist economies (FSEs). The indices reveal that central bank reform in the FSE during the 1990s has been quite ambitious. In spite of large price shocks, reformers in those countries have chosen to create central banks with levels of legal independence that are substantially higher, on average, than those of developed economies during the 1980s. The evidence in the Paper shows that CBI is unrelated to inflation during the early stages of liberalization. But with sufficiently high and sustained levels of liberalization, and controlling for other variables, legal CBI and inflation are significantly and negatively related. These findings are consistent with the view that even high CBI cannot contain the initial powerful inflationary impact of removing price controls. But once the process of liberalization has gathered sufficient momentum legal independence becomes effective in reducing inflation. The Paper also presents evidence on factors that affect the choice of CBI and it examines the relation between inflation and CBI in a broader sample.

The Inflation Bias Revisited: Theory and Some International Evidence

The Kydland-Prescott, Barro-Gordon inflation bias result relies on the presumption that policymakers aim at achieving a level of employment above potential. Both academics and policymakers have recently questioned this presumption on the ground of realism. We show that even if policymakers are content with the normal level of employment there is an inflation bias if the central bank is uncertain about the future state of the economy, and is more sensitive to policy misses leading to employment below the normal level than to policy misses leading to employment above it. This new view of the inflation bias implies that there should be a positive association between average inflation and the variance of shocks to output. Cross sectional empirical evidence from 21 developed economies supports this implication. The Paper also discusses the consequences for the transparency of monetary policy and for central bank reform.

The Effects of Uncertainty on Investment under Risk Neutrality with Endogenous Information

Using a Bayesian framework, this paper considers a risk-neutral firm which has to pick an investment project out of many that are available. It is shown that, if the firm is allowed to collect information, it will usually devote some time to information gathering before choosing. The main result is that, when uncertainty increases, the firm finds it profitable to delay investment decisions even further in order to collect more information. Thus increased uncertainty decreases the current level of investment even under risk neutrality. Another implication is that increased uncertainties cause an increase in the demand for liquid assets.

Monetary Institutions, Monopolistic Competition, Unionized Labor Markets and Economic Performance

Recent literature on the interactions between labor unions and monetary institutions features either a supply or a demand channel of monetary policy, but not both. This leads to two opposing views about the effects of central bank conservativeness. We evaluate the relative merits of those conflicting views by developing a unified framework. We find that: (i) the effect of conservativeness on employment depends on unions’ relative aversion to unemployment versus inflation, and (ii) for plausible values of this relative aversion (and more than one union), social welfare is maximized under a highly conservative central bank. We also evaluate the effects of centralization of wage bargaining and product market competition on unemployment and inflation.

Nonlinear Taylor Rules and Asymmetric Preferences in Central Banking: Evidence from the United Kingdom and the United States

This paper explores theoretically and empirically the view that Taylor rules are often nonlinear due to asymmetric central bank preferences, and that the nature of these asymmetries changes across different policy regimes. The theoretical model uses a standard new Keynesian framework to establish equivalence relations between the shape of nonlinearities in Taylor rules and asymmetries in monetary policy objectives. These relations are estimated and tested for the United Kingdom (UK) and the United States (US) over various subperiods by means of smooth transition regressions.There is often evidence in favor of nonlinear rules in both countries, and their character changes substantially over subperiods. The period preceding inflation targeting in the UK is characterized by a concave rule supporting dominant recession avoidance preferences, while the inflation targeting period is characterized by a convex rule supporting dominant inflation avoidance preferences on the part of policymakers. Dominant inflation avoidance appears during the Vietnam War in the US while, during the Burns/Miller and the Greenspan periods, recession avoidance dominates. Under Volcker the Taylor rule is linear. This is consistent with an offset by inflation avoidance of the more prevalent recession avoidance of the Fed.Findings from both countries support the view that reaction functions and the asymmetry properties of the underlying loss functions change in line with the regime and the main macroeconomic problem of the day.

Stagflation, persistent unemployment and the permanence of economic shocks

Abstract When changes occur, people do not know how long they will persist. Using a simple stochastic structure that incorporates temporary and permanent changes in an augmented IS-LM model, we show that rising prices and rising unemployment — stagflation is likely to follow a large permanent reduction in productivity. All markets clear and all expectations are rational. People learn gradually the permanent values which the economy will reach following a permanent shock and gradually adjust anticipations. In our model, optimally perceived permanent values take the form of a Koyck lag of past observations.

Central Bank Independence and Monetary Control

ing from details, these conclusions imply that inflation is lower the higher is CBI and that, given independence, countries that pre-announce monetary policy have even lower rates of inflation. Furthermore, there is no evidence that CBI retards growth or investment. As a matter of fact, for LDCs, the evidence points in the opposite direction. Low independence is associated with lower growth and investment. Some economists feel that excessive independence may interfere with the potential stabilisatory function of monetary policy. Since fluctuations in the growth rate of the economy are found to be unrelated to CBI, this does not appear to be the case. III. COMMITMENT VIA CENTRAL BANK INDEPENDENCE AND

The Limits of Transparency

The last section of the paper abstracts from feasibility constraints and discusses the desirable levels of openness in various areas of the policymaking process. It is argued that the strongest case against immediate transparency arises when the CB has private information about problems within segments of the financial system. Premature release of information may, in such a case, destroy efficient risk-sharing arrangements and long-term investments by triggering a run on the financial system. This is illustrated within the context of the classic Diamond–Dybvig model of bank runs. The paper also probes the desirable levels of transparency in other areas of the policymaking process like the banks objective function, the banks output target, forecasts of economic shocks, disagreements within the CB board and the publication of CB interest-rate forecasts.The paper also argues that there is a trade-off between full transparency and full utilization of information in setting policy and that excessive transparency may facilitate the exertion of political pressures on the CB.This paper probes the limits of transparency in monetary policymaking along two dimensions: feasibility and desirability. It argues that, due to limited knowledge about the economy, even central banks (CBs) that are considered champions of openness are not very clear about their measurement of the output gap and about their beliefs regarding the effect of policy on inflationary expectations. Consequently, feasibility constraints on transparency are more serious than stylized models of the transmission mechanism would imply. In addition, no CB has made clear statements about its objective function, including in particular the relative weight on output versus inflation stabilization, the policy discount factor and the shape of losses from the inflation and the output gaps over the possible ranges of realizations of those variables. The paper also argues that there is a trade-off between full transparency and full utilization of information in setting policy and that excessive transparency may facilitate the exertion of political pressures on the CB. The last section of the paper abstracts from feasibility constraints and discusses the desirable levels of openness in various areas of the policymaking process. It is argued that the strongest case against immediate transparency arises when the CB has private information about problems within segments of the financial system. Premature release of information may, in such a case, destroy efficient risk-sharing arrangements and long-term investments by triggering a run on the financial system. This is illustrated within the context of the classic Diamond–Dybvig model of bank runs. The paper also probes the desirable levels of transparency in other areas of the policymaking process like the banks objective function, the banks output target, forecasts of economic shocks, disagreements within the CB board and the publication of CB interest-rate forecasts.

Optimal accommodation by strong policymakers under incomplete information

Abstract This paper examines the optimal behavior of a policymaker who is able to precommit (labelled ‘strong’) when the public entertains the possibility that he is either strong or weak (unable to precommit). The main result is that, in the presence of doubts about their type, it is optimal, even for strong policymakers, to partially accommodate inflationary expectations. This contrasts with Vickers (1986) who finds that when strength is conceived in terms of the relative concern for employment the strong policymaker inflates less under incomplete than under full information. The paper also provides a theory of endogenous announcements.