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Commenting on British monetary policy in 1929, Otto Niemeyer, director of financial inquiries at H.M. Treasury, observed that —In prewar days a change in bank rate was no more regarded as the business of the Treasury than the colour which the Bank painted its front door.“ In 1987 William Greider entitled his expose of the Federal Reserve Secrets of the Temple. Since then the world of monetary policy has changed. Transparency now is a byword. Central banks are supposed to be open about their objectives, outlooks, policy strategies, and even their mistakes. The days when monetary policy deliberations were regarded as no more the business of outsiders than the color than the central bank chose to paint its door are now firmly in the past.

Or so it might seem. Assessing whether this move in the direction of policy transparency is permanent œ and if so how far it might go œ or whether it might be reversed requires understanding what lies behind the trend in the first place. One view is that transparency enhances the effectiveness of monetary policy. Transparency about monetary policy objectives, outlooks and strategies is necessary for effective communication with the markets, and effective communication is necessary for monetary policy to have stabilizing effects. Policy transparency makes it easier for observers to anticipate central bank actions and minimizes disruptions when policies change. It enhances the ability of policy makers to manage expectations, which is a key channel through which monetary policy affects outcomes. Transparency about not just current but also expected future policy gives the central bank leverage over long-term interest rates (which depend on expectations) and thus provides an important mechanism for influencing consumption and investment.

The seminal research on this subject built on the Barro-Gordon (1983) model in which wages are set now on the basis of expected future monetary policy. Imagine, for example, that inflationary pressures are building and unions contemplate raising their wage demands. If the central bank is transparent about the priority it attaches to price stability, the risk it perceives that inflation will exceed its target, and the likelihood of having to respond by raising interest rates, then wage setters will have reason to anticipate that inflationary pressures will subside. They will be less likely to demand higher wages now that would, require costly and difficult wage reductions in the future. See for example Geraats (2002a,b).

The disruptions to the economy from policies to contain inflation would be less. And monetary policy makers are less likely to fall prey to an expectations trap in which expectations drift off in ways that force them into unpalatable policy choices.

Transparency thus allows the central bank to more effectively communicate with
the markets. It helps it to credibly commit. It is a way for monetary policy makers to communicate the importance they attach to price stability This inturn enables them to respond flexibly to disturbances without undermining confidence in their commitment to their long-term target.

A second view is that transparency is a mechanism for democratic accountability in a world of policy discretion and central bank independence. Once upon a time central bank policy was constrained by rules like those of the gold standard, if not absolutely then at least more tightly than today. Central banks may have had statutory independence œ many of them were in fact still private banks œ but they did not have policy independence. The demise of the gold standard was associated with the spread of modern central banking but also with increasing central bank dependence on the government (as alluded to in Niemeyer‘s quote above). At this stage there was no question about the political accountability of the central bank. More recently has there been recognition of the efficiency advantages of delegating the conduct of monetary policy to an independent entity. Moreover, with the move away from pegged exchange rates, central banks have acquired greater discretion over the stance of policy. But with the growth of independent powers comes a need for democratic accountability, for assurance that the independent technocrats now with discretion over monetary policy decisions take those decisions in a manner consistent with the public interest and will be taken to task for failing to do so. This mechanism for democratic accountability will be effective only if the central bank is transparent about its decisions œ only if those deciding monetary policy cannot claim that their policy decisions are, in fact, in the public interest for reasons that only they understand. In the absence of adequate transparency, suspicion about central bank motives may develop, and pressures to curb the institution‘s independence may be irresistible.

Both rationales have been questioned. If asymmetric information is a distortion, then the theory of the second best suggests that removing one distortion in the presence of another may not be welfare improving. It is not hard to construct scenarios in which additional transparency destabilizes expectations and accentuates financial market volatility. Similarly, there are critics of the view that transparency can substitute adequately for direct political sanctions as a mechanism for holding monetary policy makers accountable.

In addition, even those who embrace these efficiency- and accountability-based arguments wonder whether central bank transparency can go too far. The European Central Bank has justified its refusal to publish the minutes and voting records of its board on the grounds that individual members would then be subject to pressure from special interests (national interests, in its context) that compromised their independence and led to inefficient policy decisions. Clare and Courtenay (2001) argue that minutes describing contentious discussion among central bank board members can heighten asset- price volatility, suggesting that copious information only confuses investors. More generally, van der Cruijsen, Eijffinger and Hoogduin (2008) suggest that agents may be confused by the large and increasing amount of information with which they are bombarded in a highly transparent regime. They suggest that excessive transparency may cause agents to realize how uncertain the central bank is about economic conditions and the efficacy of policy, in turn heightening volatility. Others ask whether requiring the central bank to provide detailed information about its intermediate targets, only to miss them, might similarly confuse and raise questions about the competence of policy makers. Thus Good hart (2001) questions the efficacy of requiring the central bank to provide information on not just, inter alia, inflation forecasts but also its forecasts for the future path of the monetary policy instrument, on the grounds that this would so complicate decision making (board members would have to agree on an entire trajectory for their policy instrument at each decision point) as to potentially undermine effective decision making. Mishkin (2004) warns that a high degree of transparency might disrupt communication with the public, which would not easily understand that forecasts for the policy instrument are conditional on the future state of the economy, and which might misinterpret changes in the forecast (or deviations between forecast and realized rates) as the central bank reneging on its commitments.

We cannot resolve these debates here, but the evidence we present speaks to them. Specifically, in this paper, which is the latest in a series we have writing on the subject of central bank transparency, we undertake three tasks. First, we document changes in the prevalence of central bank transparency, updating our measures through 2006. Second, we analyze the determinants of the degree of transparency, focusing here on the role of political variables. Third, we examine the consequences for monetary-policy outcomes such as inflation variability and inflation persistence. Here we probe for nonlinear effects of transparency on policy outcomes as a way of providing a provisionalanswer to Mishkin‘s (2004) question of whether —transparency can go too far.“ A methodologically significant aspect of our work is that we consider the determinants of transparency and the effects using a unified analytical framework. This means that we can use our analysis of the determinants to identify instrumental variables that address the concern that an observed correlation between outcomes and transparency reflects the impact of the former on the latter, rather than the other way around.

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