DP7078 When Can Central Banks Anchor Expectations? Policy communication and controllability

Author(s): Nicola Acocella , Giovanni Di Bartolomeo , Andrew Hughes Hallett

Publication Date: December 2008

Keyword(s): controllability , fiscal policy , monetary policy , policy neutrality , Rational expectations

JEL(s): C61 , C62 , E52 , E61 , E62

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP7078.asp.asp

Rational expectations are often used as a strong argument against policy activism, as they may undermine or neutralize the policymaker’s actions. Although this sometimes happens, rational expectations do not always imply policy invariance or ineffectiveness. In fact, in certain circumstances rational expectations can enhance our power to control an economy over time. In those cases, policy announcements, properly communicated, can be used to extend the impact of conventional policy instruments. In this paper we present a general forward-looking policy framework and use it to provide a formal justification for attempting to anchor expectations, and as a possible justification for publishing interest rate forecasts or tax rate projections. This approach allows us to test when policymakers can and cannot expect to be able to manage expectations.