It is widely believed that monetary policy outcomes are generally enhanced if the conduct of policy by the central bank is widely understood by other agents in the economy. This widespread belief has given rise to a number of attempts to measure the 'transparency' of monetary policy in various regimes. In this research paper I have tried to explain about Central Bank and Transparency. What is meant by Central Bank Transparency ? Its types and effects and in the conclusion I have my point of view regarding Transparency at central Bank, its advantages and why its necessary.
Central Bank and Transparency
A Central Bank or a Reserve Bank is defined as the organisation with in a specific country or coalition that regulates all of the currency supplies and related policies for that particular region. A Central Bank performs various actions, but the most important work or duty of a central bank is to make certain that the national currency and money supply remains stable. Central Banks may be a government owned and controlled or may be run under the regulations that are created specifically to limit too much government interference.
There are some specific functions of a Central Bank that may include different tasks. The functions may include distribution of currency and implementation of monetary policy. Regulations of Banking industry and setting of official interest rates could also be duties of Central Bank.
Transparency means that Central Bank provides to the general public and the market with all the relevant information on its strategy, assessments and policy decisions as well as its procedures in an open, clear and timely market.
A Central Bank is transparent when it provides at all times sufficient information for the public to understand the policy regime, to check whether the bank's actions matches the regime and to pass judgement on its performance.
Transparency at Central Banks
Transparency at the Central Banks is one of the main features of the monetary policy making. Earlier Central Banks have been associated with secrecy. This has changed gradually in the last 10 years. In this project, I have researched about the effects of Central Bank transparency on Inflation and output gap. From mid 1990s there has been a great emphasis on the transparency in the economic policy making. One of the most significant differences between central banking of today and the central banking in early historical period is Transparency.
Central Banks used to operate in a very secretive manner, but if we take into account last two decades then we come that Central Banks have become quite transparent in terms of their operations and working. As a result of being independent and transparent, they have become quite important and accountable to public. Debate of transparency has been fostered by the additional requirement of greater accountability in order to justify greater independence. If we talk about benefits of transparency predicted by the theoretical models it is that it enhances the credibility, reputation and flexibility of monetary policy, which suggests that increased transparency should result in lower interest rates.
Transparency is not only famous in developed countries, where it all started like Canada, New Zealand and United Kingdom, but also in developing countries like Brazil. It was found in a survey that 74% of central banks consider Transparency as a key feature or factor in framing monetary policies.
Transparency is referred to such an environment in which the objectives of policy, its legal institutional and economic framework, policy decisions and their underlying principle ,data and information related to monetary and financial policies and terms of agencies accountability are provided to the public in a complete, accessible and timely manner.
Transparency means how open a central bank is clearing up the reason and rationale behind its specific policies. The Central Bank should also explain the economic environment in which it expects its actions to be felt. A trend towards increased transparency of Central Banks can be witnessed in most countries of the world.
There are two main reasons to promote transparency at the Central Bank s. First, Efficiency of economic and financial policies can be strengthen if the goals and the instruments of the central bank policy are known to the public and if the authorities can make a convincing commitment of making them, by making available more information about monetary and financial policies ,good transparency practices promote the likely efficiency of markets.
Second, the democratic accountability of central banks is another reason to promote transparency. Good control calls for central banks to be accountable, particularly when granted a high degree of independence. Transparency is the mandate of the Central Banks and clear rules of course of action for its operations are good governance and facilitate policy stability.
Transparency thus allows the Central Banks to correspond more effectively with the markets. It is a way for fiscal policy makers to communicate the importance they attach to price constancy. Thus in turn enables them to respond flexibility to disturbances without undermining confidence in their obligation to their long term target.
Another view is that Transparency is a system for democratic accountability in a world of policy discretion and central bank independence. Once a while central bank policy was controlled by the rules like those of the gold standard, if not absolutely then at least more tightly than today. Central Banks may have had legal independence but many of them were in fact still private banks, but they did not have autonomy of policy. The end of the gold standard was coupled with the spread of modern central banking but also with increasing central bank independence on the government. At this stage there was no question about the political liability of the central banks. More recently there has been appreciation of the efficiency advantages of delegating the conduct of monetary policy to a sovereign entity. Moreover, with the move away from pegged exchange rates, Central Banks have acquired greater maturity over the stance of policy. But with the growth of independent powers comes a need for democratic accountability, for promise that the independent technocrats now with discretion over monetary policy decisions take those decisions in a manner consistent with the public interest and will be taken to task for failing to do so. This mechanism for democratic accountability will be helpful in transparency establishment.
Effects of Transparency
Transparency refers to the physical properties of an object to transmit light, which means one can see through it. In an economic framework a useful definition of transparency is the existence of symmetric information, lack of transparency or opacity then refers to asymmetric information. This means that opacity generates ambiguity. However, transparency is not equivalent to complete certainty. For example , in the case of monetary policy, the central bank and private sector could both face improbability about the structure of the economy, but as long as both have the same information and are aware of it, transparency prevails.
The definition of transparency focuses on information that agents actually have, and not on the act of disclosing information .The reason is that unrestricted availability of data need not be sufficient to achieve transparency. If management of data is required to extract useful information and agents are controlled by limited resources, then asymmetric information could persist. In addition, there may be social linguistic reasons that cause difficulties in effective communication of relevant information. This is further discussed in the context of monetary policy by winkler, who proposes to view transparency in terms of openness, simplicity, honesty and common acceptance.
If we talk about the effects of monetary policy transparency, then we come to know that some earlier studies suggest that greater transparency should be associated with a drop in uncertainty about future policy actions and thus with a decrease in inflation volatility. Consistent with the hypothesis, Demertzis and Hughes, employing the Eijffinger Gerrads index for 2001, find a negative relationship between inflation variability and Central bank Transparency. Other studies suggests that there is less variability and diffusion in inflation expectations when Central Bank publish statistical targets for inflation, still others suggests that greater transparency should be associated with lower inflation resolution, in so far as the credibility of monetary policy is enhanced and market participants do not extrapolate future inflation from current inflation.
Here we consider the impact on inflation variability and inflation persistence. In contrast to previous studies we acknowledge the endogeneity of monetary policy transparency by the political variables.
To understand the economic cost of transparency it is helpful to distinguish between the two effects. First, asymmetric information generates ambiguity for the agents that experience the information disadvantage, and provides the opportunity for others to directly take advantage of the presence of private information; this could be labeled the Uncertainty Effect. Second, those with access to private information may try to influence the beliefs of others through signaling , the response to the signal could influence the senders incentives, and there by indirectly alter economic behavior; this could be called the Incentive Effect of a symmetric information.
One might expect that the cry off In uncertainty due to transparency would generally be interest enhancing, because it reduces forecast errors and the expected variability of variables subject to uncertainty. Morris and Shin consider uncertainty in a richer setting. They evaluate a model in which a principal, who only controls the disorderliness of a public signal of the state of the economy, would like to coordinate the average action of heterogeneous agents with respect to that state. Each agent also has access to a private signal of the state, and aims to take an action that is suitable for the state of the economy and regulate its actions to those of other agents. So, when the public signal is relatively noisy this exacerbates the volatility of the average action, which horns the principal.
The basis of the Incentive Effect is the desire of an agent with private information to manipulate the beliefs of others. The response by the receiver of signal could in turn shape the senders incentives and there by affects the sender's behaviour. The latter is the Incentive effect at the information asymmetry. Since a large portion of the literature on Bank Transparency employs calculated monetary policy games; it is useful to analyze such an incentive effect for a stylized model in the spirit of the influential paper by Kydland and Prescott.
There are many papers in which status reduces the inflation bias in a dynamic setting due to the incentives generated by asymmetric information about the central banks preference. Notable include Backus and Drifill and Baro, who analyze reputation signalling with two central bank types, and Cukierman and Meltzer, who considers a continuum of Central Bank types in the presence of an additional information asymmetry about monetary control errors one could argue that this reputation literate gives rise to two policy implications. First, it is desirable to have monetary policy makers preferences appears healthy as it induces a beneficial incentive effect. This suggests that that it may be helpful to have turnover of policy makers, for instance by having partially overlapping tenures.
Aspects of Transparency
Transparency of economic policy can be defined as the point to which central banks reveal information related to the policy-making process. It seems therefore natural to differentiate, at the different phases of the process, five aspects of transparency; Political, Economic, Procedural, Policy and Operational transparency. Each of these aspects may give rise to different motives for transparency.
Theoretical offerings on Political transparency shed light on the effect of asymmetric information about the policy makers inclination, the cost of explicit inflation targets and institutional arrangements like Central Bank independence contracts and overrides mechanism.
Political Transparency refers to honesty about policy objectives; this comprises a report of the formal objectives of economic policy, including an open prioritisation in case of potentially conflicting goals, and quantitative targets. Political Transparency is enhanced by institutional engagements, like Central bank independence, Central bank contracts and explicit override mechanism, because they insure that there is no undue influence or political pressure to diverge from stated objectives.
The theoretical literature on Economic Transparency mostly considers the consequences of asymmetric information about Economic data and or forecasts. In particular, both the central banks inflation target and the public's inflation expectations are private information. Tarkka and Mayes analyze the effect of asymmetric information about the Central banks estimate of the public inflation expectations. They find that the publication of unconditional Central Bank forecasts for inflation and output could communicate both the central bank s inflation target and its assessment of private sector expectations, and lead to greater predictability of monetary policy and less variability of output.
Economic Transparency focuses on the Economic information that is used for monetary policy. This includes the Economic data that Central Ban uses, the policy models it employs to construct Economic forecasts or evaluate the impact of its decisions, and the internal forecasts the Central Bank relies on.
Procedural Transparency is about the way monetary policy decisions are taken, it involves an open monetary policy rule or approach that describes the monetary policy framework , and an account of the actual policy discussions and now the policy decisions was reached, which is achieved by the release of minutes and voting records.
Uncertainty and Incentive effects also play a role in Procedural Transparency , which is analyzed by Gersbach and Hahn(2001 a) and Gerbasch and Hahn (2001 b) who both focus on the publication of individual voting records and incorporate accountability through re-election.
Gersbach and Hahn consider a two period monetary policy game in which the government elects Central bankers for one period at a time .Secrecy about individual voting records inhibit the assessment of a Central Bank skill before re election, which generates a unfavourable Uncertainty Effect in the second period. On the other hand, Transparency creates a strategic incentive effect in the first period as in competent Central Bankers refuse to abstain from voting as it would reveal their incompetence instead, they bother the decision by random votes to maximize their chances of re election.
Policy Transparency means a timely declaration of policy decisions. In addition, it includes an account of the decision and a policy preference or indication of likely future policy actions. The latter is applicable because monetary policy actions are typically made in separate steps; a central bank may be inclined to change the policy instrument, but decide to wait until additional evidence warrants moving further.
There are several models that analyze the penalty of transparency about policy decisions, and they all focus on non-borrowed reserves targeting where the policy instrument is a target for the money supply. In the market for bank reserves ,the interbank rate adjusts to certify symmetry between the demand and supply of total reserves , which consists of borrowed and Non-borrowed reserves targeting is modelled as a simple reaction function for the supply of Non-Borrowed reserves by the central bank that depends on the interbank rate and the Central bank short term money target. In case of policy transparency this money target is disclosed .The models differ in their information structure under policy opacity, but they have in common that there are money market uproar that are private information to the central bank. So, that the policy target cannot be deduced from interbank rate.
Operational Transparency concerns the execution of the central bank's policy actions. It involves a debate of control errors in achieving the operational targets of monetary policy and macroeconomic disturbances that effect the communication of monetary policy.
After analyzing the report of Central Bank transparency, I have drawn a conclusion that, there are basically two main reasons to encourage the transparency of Central Banks. First, the effectiveness of monetary and financial policies can be strengthened if the goals and instruments of the central bank s policy are known to the public and if the system can make credible commitment to meeting them .By making accessible more information about monetary and financial policies , good transparency practices endorse the possible efficiency of markets.
Second, the democratic liability of Central Banks is another reason to endorse transparency .Good control calls for Central Banks to be responsible particularly when granted a high degree of self-government. Transparency in the authorization of the central banks and clear rules of procedure for its operations ensure god control and make possible policy stability.
This research report set out to show that a more open exchange of ideas between central bank policy makers and the general public is conductive for greater market efficiency. A simple model of transparency in central bank's policy making shows that increases in the level of transparency could not affect the average levels of inflation and achieved. But it would decrease the degree of unpredictability in both inflation and output gap levels and more so, in output volatility if the central bank is traditionalist.
The case in favour of transparency is strong, the presence of information unevenness between the central bank and public calls for full transparency: the central bank knows more about itself; its instruments and its intentions than the public does. This irregularity can create misunderstandings. Transparency increases credibility and reduces Uncertainty.
The recent trends towards greater transparency and responsibility are obviously beneficial and should be encouraged. Transparency provides for greater honesty and allows decisions to be better conversant while liability imposes firmer authority on the decision makers. It is important to differentiate clearly between the lack of transparency which refers to the possession of precise information which Central bank chooses, deliberately not to reveal to the private sector; and that lack of transparency that arises through doubt, meaning that central bank does not have accurate information itself- although it is improperly prepared to release what information it does have. These two cases may have quite diverse consequences and theses experimental results suggests that what passes for a lack of transparency in conservative discussions may be as much latter as the former.
- Central Bank Transparency And Private Information In a Dynamic Model.By Joseph G. Pearlman Work Paper Series No. 455/March 2005.
- Central Bank Independence and Transparency : Evolution and EffectivenessBy Christopher Crowe and Ellen E. Meade. (IMF Working Paper WP/08/119 )
- Central Bank Transparency By Petra M. Gerrats University Of Cambridge March 2002.
- Through the Looking Glass: Central Bank Transparency By Alan S. Blinder, Princeton University. (CEPS Working Paper No.86, December 2002.)
- Six Practical Views Of Central Bank Transparency By Adam S. Poen, Senior Fellow Institute For International Economics, May 6, 2002.
- The Economic Impact of Central Bank Transparency: A Survey By Carin Van Der Cruisjen, Sylvester Eijffinger January 2007 ( Discussion Paper ISSN 0924-785).