The Advantage of Transparency in Monetary Policy Instruments

Abstract

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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