Optimal Monetary Policy and Transparency under Informational Friction

Abstract

This paper examines optimal monetary policy and central bank transparency in an economy where firms set prices under informational frictions. The economy modeled in this paper is subject to two types of shocks that determine the efficient level of output and firms’ desired mark-ups. To minimize the welfare-reducing output gap and price dispersion among firms, the central bank controls firms’ incentives and expectations by using a monetary instrument and by disclosing information on the fundamentals. This paper shows that the optimal policy comprises the partial disclosure of information and the adjustment of the monetary instrument contingent on the disclosed information. Under this optimal policy, public information is formed by the weighted difference of the two shocks in order to induce a negative correlation between their conditional expectations, while monetary policy should offset the detrimental effect of such a disclosure policy on price stabilization.