In the recent past, few central banks would have placed heavy emphasis on maximizing public understanding. Moreover, there is no general presumption that increasing common knowledge in society improves welfare. The transparency literature is rife with examples where this is not the case, for example, Faust and Svensson.
Indeed, much of the transparency literature can be viewed as a study of when it is and is not optimal for the central bank to surprise the public deliberately. This conventional transparency literature does not address three arguments in favor of clear communication that are stressed by ITF advocates and many other commentators.
First, as Greenspan states, "Openness is an obligation of a central bank in a free and democratic society." A great many conservative and liberal economists have supported this view. Deliberately surprising the public, even for its own good, is not the proper role of a central bank, in this view.
The second reason for clarity is that, as Lucas makes clear, what constitutes optimal policy is inextricably linked with public expectations about policy. The effects of a given policy action are not even de¦ned without a treatment of policy expectations. More recently, discussions of the liquidity trap have reminded us of this point. The liquidity trap case drives the point home because, under certain assumptions, expanding the monetary base in a liquidity trap has no direct effects on the economy. Any effects result from changes in expectations.
Lucas argues that, even away from the liquidity trap, both the agent's problem and the central bank's problem in practice are intractable unless the public understands what the central bank is doing. An assumption about public understanding of the future course of policy is a precondition for coherent analysis of current policy.
The third argument in favor of clear communication is that it may alter incentives in a beneficial way. Many variations of this idea have been studied in the political economy literature.
1. The author would most likely agree with all of the following statements EXCEPT:A. transparency literature discusses the impact of intentionally suppressing policy decisions
B. there are secondary bene¦ts to an open and public fiscal policy
C. optimal fiscal policy is tied to public expectations
D. a liquidity trap has no direct effect on the economy
E. central banks future in democratic societies should publicize their current and future fiscal policies
2. According to the passage, Faust and Scensson would most likely agree with which of the following statements?A. Clear communication is a key to altering incentives in bene¦cial ways
B. Public expectations should be taken into account when setting fiscal policy
C. The liquidity trap is invalid in current economic thinking
D. There are many circumstances where it is appropriate for central banks to obscure their activities
E. Conventional transparency literature is no longer valid in modern economic planning
3. The main concern of the passage is toA. advocate particular strategies for future central bank policy
B. argue the validity of a departure from the conventional wisdom of the past
C. explain differences in the function of transparency literature
D. analyze and explain a political phenomenon
E. evaluate the effectiveness of certain kinds economic policy
4. In the third paragraph, the author uses a quote by Greenspan to:A. express a common view
B. detail a fiscal policy
C. describe the impact of a decision
D. reinforce a previous declaration
E. offer an explanation of a specific phenomenon