Staff Report 297

The Advantage of Transparency in Monetary Policy Instruments

Patrick J. Kehoe | Stanford University, University College London, Federal Reserve Bank of Minneapolis
Andrew Atkeson | Federal Reserve Bank of Minneapolis Consultant and UCLA

Revised July 1, 2006

Monetary policy instruments differ in tightness—how closely they are linked to inflation—and transparency—how easily they can be monitored. Tightness is always desirable in a monetary policy instrument; when is transparency? When a government cannot commit to follow a given policy. We apply this argument to a classic question: Is the exchange rate or the money growth rate the better monetary policy instrument? We show that if the instruments are equally tight and a government cannot commit to a policy, then the exchange rate’s greater transparency gives it an advantage as a monetary policy instrument.

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