The paper “Central Bank Communication, Adaptive Learning and Monetary Policy Effectiveness”, co-authored by Professor Yumei GUO of the School of Finance at CUFE and Professor Xuan ZHOU of the School of Economics at Renmin University of China, was published in the 4th issue of “Economic Research Journal” in 2018.

Abstract: Central banks communicate with the market about macroeconomic performance and monetary policy intentions to coordinate market expectations. While central banks in developed countries have placed a growing emphasis on communication and information disclosure, the People’s Bank of China ( PBC) does not pay enough attention to public communication. The Chinese economy is experiencing structural transformations in many areas, and there are calls for monetary policy to play a greater role. However, due to financial innovation, the effectiveness of quantitative monetary policy has decreased, while the price-based monetary policy has not been well established. Could the PBC improve the effectiveness of monetary policy by communicating more to the public? Prior studies recognize the positive role of central bank communication, but few investigate the mechanism through which a central bank’s communication strategy impacts the effectiveness of monetary policy using DSGE models.

This paper introduces adaptive learning, public information and private information into a standard DSGE model to study the impact of central bank communication on public learning and expectations coordination in a dynamic setting. We assume that individuals know the correct structure of the economy but do not know the exact parameters. Therefore, they adaptively learn from public and private information to update their parameter estimates and form expectations. Due to information noise and learning biases, the public’s expectations deviate from rational expectations. We show that if the central bank’s public information is more accurate than private information, central bank communication can improve market expectations by reducing information and learning biases, accelerating the convergence toward the rational expectations equilibrium. This indicates that central bank communication can improve the effectiveness of monetary policy. Welfare analysis implies that the central bank can stabilize output and inflation through communication, reducing the gross social welfare loss. In our baseline calibration, central bank communication increases welfare by 15% relative to noncommunication. The more accurate the central bank’s information is, the less the welfare loss is and the more effective the monetary policy is． Moreover，when the central bank’s public information is more accurate than private information, the public increases the relative weight they place on public information. This reflects a greater coordination motive and will further enhance the effectiveness of monetary policy. If public information is less accurate than private information, then central bank communication may magnify the information noise and decrease social welfare.

We contribute to the literature in two ways． First，we discover a new channel through which central bank communication affects the effectiveness of monetary policy. We decompose the public’s expectation bias relative to rational expectations into an information bias and a learning bias. Central bank communication can reduce both biases by improving the precision of the information it discloses. Communication not only improves information quality, but also affects the public’s learning process. The interaction between the public’s adaptive learning and the central bank’s communication is important. The model we construct and the channel we identify shed new light on the theory of how central bank communication affects the effectiveness of monetary policy. Second, we prove that this effect is limited. Prior studies often assume that the central bank communicates information that is superior to private information. We investigate the case when the central bank communicates less accurate information than the public in a dynamic macroeconomic environment and find that central bank communication in such a case tends to hamper the public’s learning process and decrease the effectiveness of monetary policy. Therefore, to make monetary policy more effective, it is important for the PBC to increase the precision of the information it discloses.

Keywords: Central Bank Communication; Adaptive Learning; Monetary Policy; Public Information; Private Information