Reliability of Policy Announcements and the Effects of Monetary Policy

Monetary authorities regularly announce targets for monetary growth, but the market may not completely trust these announcements because they may not always be truthful. Hence, the market does not have perfect knowledge about future monetary policy and must form its expectations on the basis of information it can extract from the announcements and its observations of the actual money supply. This paper asks how the macroeeonomic effect of monetary policy might be altered by more reliable policy announcements, in the setting of a medium-sized open economy. It is found that, contrary to the full-information case, a reduction in monetary growth of l~o may lead on impact to a reduction in inflation of much less than I~0, if the announcements are not very credible. The output costs of lowering inflation are smaller both in the short run and the long run, the more reliable the announcements. However, the plausibility of announcements does not affect the output loss for a given appreciation of the currency. Fluctuations in the exchange rate that are attributable to monetary disturbances beyond the policy-makers' control can nonetheless be dampened by making announcements that are more highly correlated with the truth.