On Credible Monetary Policy and Private Government Information

Abstract

Credible and optimal monetary policies are considered in environments in which the government observes a signal that is correlated with the state of the economy. When the signal is public information it is optimal for monetary policy to be conditioned upon it. The extent to which such conditioning should occur when the signal is the private information of the government depends upon the government's incentives to misrepresent information. It is shown that in some cases the Ramsey policy is incentive compatible, in others it is not. In the latter cases, policy must be constrained to be incentive compatible. This may result in “penalty phases” along the equilibrium path following apparent “mistakes” by the policy maker; it may result in the optimal monetary policy making no use of the signal. Journal of Economic Literature Classification Numbers: C73, E52, E58.