Cheap Talk in Monetary Policy: A General Equilibrium Approach

In a general equilibrium model with a central bank (CB) and a continuum of private agents, there are two groups of agents, owners and workers. The objective of the CB is to maximize a weighted average of utilities of these two groups. There are two possible types of the CB, differing in the relative weights in averaging the two groups’ utilities. The realized type of the CB is private information. It is shown that besides babbling equilibria there exist more informative, fully revealing, equilibria in which the CB fully reveals its true type. Conditions are found under which these more informative equilibria are better than babbling equilibria from social welfare point of view. Other things being equal, if the range of possible monetary injections is small, then the babbling equilibria are welfare superior to the fully revealing equilibria. On the other hand, if this range is large, then the fully revealing equilibria are superior to the babbling ones. ∗Department of Economics, McGill University, 855 Sherbrooke Street West, Montreal, QC, H3A 2T7, Canada. Tel.: (514) 398-4827; fax: (514) 398-4938. E-mail: [email protected]