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Central bank's two-way communication with the public and inflation dynamics

November 2008
Kosuke Aoki*1
Takeshi Kimura*2

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Abstract

Using a model of island economy where financial markets aggregate dispersed information of the public, we analyze how two-way communication between the central bank and the public affects inflation dynamics. When inflation target is observable and credible to the public, markets provide the bank with information about the aggregate state of the economy, and hence the bank can stabilize inflation. However, when inflation target is unobservable or less credible, the public updates their perceived inflation target and the information revealed from markets to the bank becomes less perfect. The degree of uncertainty facing the bank crucially depends on how two-way communication works.

Keywords:
Monetary policy, central bank communication, inflation target

JEL Codes:
E31, E52, E58

Earlier version of the paper was entitled "Uncertainty about perceived inflation target and monetary policy."
The authors are grateful for comments from Nicoletta Baniti, Martin Bodenstein, Anton Braun, Shinichi Fukuda, Bernardo Guimaraes, Athanasios Orphanides, Nobuyuki Oda, Pedro Teles, Hiroshi Ugai, Takashi Ui, seminar participants at Bank of Canada, Bank of England, Bank of Japan, Bank of Portugal, BIS, Cambridge, ESSIM 2005, LSE, University of Tokyo, Hitotsubashi, Kobe, Osaka and Tohoku Universities, as well as participants at the Joint Deutsche Bundesbank/Federal Reserve Bank of Cleveland Conference, and Third Banca d'Italia/CEPR Conference on Money, Banking and Finance. The authors also thank Naohisa Hirakata for his excellent research assistance. Aoki thanks hospitality of the Bank of Japan. The paper represents the views and analysis of the authors and should not be thought to represent those of the Bank of Japan.

  • *1 Corresponding author. Department of Economics, LSE. Houghton Street, London, WC2A 2AE, UK.
    e-mail: k.aoki@lse.ac.uk
  • *2 Financial Markets Department, Bank of Japan. 2-1-1 Nihonbashi- Hongokucho, Chuo-ku,Tokyo, Japan.
    e-mail: takeshi.kimura@boj.or.jp

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