Optimal central bank transparency

Should central banks increase their degree of transparency any further? We show that there is likely to be an optimal intermediate degree of central bank transparency. Up to this optimum more transparency is desirable: it improves the quality of private sector inflation forecasts. But beyond the optimum people might: (1) start to attach too much weight to the conditionality of their forecasts, and/or (2) get confused by the large and increasing amount of information they receive. This deteriorates the (perceived) quality of private sector inflation forecasts. As a result, inflation is set in a more backward looking manner resulting in higher inflation persistence. By using a large scale panel data set on the transparency of central banks we find empirical support for an optimal intermediate degree of transparency at which inflation persistence is minimized. Our results indicate that while several central banks would benefit from further transparency increases, some already have reached the optimal level.