Gradually, a majority of economists have come to view "transparency" in monetary policy as desirable. Transparent policies are overwhelmingly seen as both more effective, and more likely to enhance and nurture environments of accountability. But while the theoretical advantages of transparency have been subject to exhaustive academic scrutiny, this has been far from the case in terms of empirical analysis.
INSEAD Professor of Economics Antonio Fatás, Associate Professor of Economics Ilian Mihov, together with Professor Andrew Rose of the University of California, have developed an annual data set consisting of macroeconomic statistics from 42 nations between 1960 to 2000. Their working paper posits that, in practice, countries with more effectively transparent targets for monetary policy consistently manage to achieve lower rates of inflation.
Taking into account various determinants of inflation (i.e., fiscal policy, business cycles, exposure to international trade, etc.), as well as other related factors, the authors have determined that "both having and hitting quantitative targets for monetary policy is systematically and robustly associated with lower inflation".
Demonstrating that their current studies are related to a number of other classic problems in economics, they provide a brief, but comprehensive review of contemporary literature relating to relevant transparency issues, then summarise what they regard as their most significant insights.
With regards to exchange rate regimes - the primary focal area for much recent scholarly debate regarding choices of monetary instruments at the disposal of central banks and other policy makers - the authors submit that "the macroeconomic effect of the exchange rate regime is still an open question, one that is associated with many controversies in both the international and monetary economics literatures". In proposing that there remain many substantial disagreements vis-à-vis the relative empirical importance of these factors, they conclude that "as a result, when it comes to the best monetary policy for a given country, most of the predictions are inconclusive, as they depend on a variety of assumptions that can only be validated empirically".
The paper offers insight into the two standard approaches - and limitations thereof - inherent to the classification of exchange rate regimes: the officially declared, de jure classification, or the actual de facto behaviour of such regimes. While asserting that the distinction between words and actions clearly matters greatly for the most critical factors associated with monetary policy targets, the authors choose, rather than attempting to resolve this key debate on a conceptual level, "to simply look at both the de facto regime [of a given economy] and whether or not it is actually hit in practice". They then acknowledge that assessing exchange rates targets "by their actions, not their words" has led them to various procedural difficulties, and summarise these.
The authors' benchmark model combined data from three types of targets for monetary policy - exchange rate, money growth, and inflation targets. In evaluating the results attained through their benchmark model, the authors find that "at first blush, it seems that countries with transparent (quantitative) de jure monetary targets experience lower inflation". However, while they viewed their preliminary findings as generally quite positive, they then engaged in sensitivity analysis in an effort to resolve issues associated with a number of potentially important omitted variables and econometric complications resulting from their initial findings.
The authors ultimately concur that "having a quantitative de jure target for [a given] monetary authority tends to lower inflation and smooth business cycles, and that "hitting that target de facto has further positive effects." Furthermore, "these effects are economically large, typically statistically significant and reasonably insensitive to perturbations in our economic methodology".