Observing and shaping the market: the dilemma of central banks
Romain Baeriswyl, Camille Cornand and Bruno Ziliotto
D82, E52, E58
Endogenous information, overreaction, central bank communication
While the central bank observes market activity to assess economic fundamentals, it shapes the market outcome through the conduct of monetary policy. A dilemma arises from this dual role because the more the central bank shapes the market, the more it influences the informational content of market prices.
This paper analyses the optimal monetary policy action and disclosure when central bank information is endogenous for three operational frameworks: pure communication, action and communication, and signalling action. Although taking the endogenous nature of central bank information into account calls for less activism from the central bank, full transparency remains optimal when the weight assigned to price dispersion in social welfare takes on its micro-founded value.