Transparency on financial stability not always optimal – Fed paper

Under some conditions it may be optimal for central banks to avoid revealing too much information on the state of the credit cycle, new research published by the Federal Reserve finds.

David Arseneau studies the question of when a central bank can benefit from being better informed than the wider population. He finds that when financial stability vulnerabilities are “complex” – a non-linear crisis probability function – central banks can use macro-prudential policy to affect real economic activity by delivering policy surprises.

But getting the timing right is tricky, Arseneau adds. He finds it is only optimal to hold back information at certain points in the credit cycle, namely when credit is expanding and the probability of a crisis is high.

This implies central banks need to be “extremely well informed” about financial conditions if they are to achieve optimal communications, he says.

Furthermore, central banks may face a time inconsistency problem. A central bank will generally commit in advance to publish a financial stability report; it then becomes costly to stop publishing it, even if that might have been the optimal policy choice, Arseneau says.