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 | Consultant

Revised July 1, 2006

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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