Monetary authority's transparency and income inequality

• Published date: 01 November 2018
• Date: 01 November 2018
• Author: Diogo Martins Esteves,Helder Ferreira Mendonça
• DOI: http://doi.org/10.1111/rode.12523

REGULAR ARTICLE

Monetary authority's transparency and income

inequality

Helder Ferreira de Mendonça

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Diogo Martins Esteves

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1

Fluminense Federal University, Brazil,

and National Council for Scientific and

Technological Development (CNPq),

Brazil

2

Ministry of Finance, Brasília, Brazil

Correspondence

Helder Ferreira de Mendonça, Rua Dr.

Sodré, 59, Vila Suíça, Miguel Pereira,

Rio de Janeiro, CEP 26900-000, Brazil.

Email: helderfm@hotmail.com

Abstract

This paper analyzes how transparency from the monetary

authority can affect the income inequality. The contribu-

tion is twofold. In the first part, we develop a theoretical

model that considers heterogenous agent shopping‐time

economy with a lack of transaction technology between

rich and poor to observe the effect of central bank trans-

parency on income inequality. The second part provides

empirical evidence through panel data methodology that

draws on 37 developing countries for the period 1992 to

2012. Our findings indicate that, in general, the monetary

authority's transparency is an important tool to reduce

income inequality between rich and poor when there are

some advantages for the first group.

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INTRODUCTION

Modern central banks have focus on price stability and have developed institutional framework in

order to increase their transparency. In particular, transparency is a tool through which the monetary

authority interacts directly with the public (Blinder, Ehrmann, Fratzscher, De Haan, & Jansen,

2008). As pointed out by Faust and Svensson (2001), transparency in monetary policy improves

social welfare because it reduces inflation bias, inflation variability, and employment variability. The

most common definition of transparency corresponds to symmetric information (Geraats, 2002).

Hence, based on assumptions from the first fundamental welfare theorem, greater transparency (less

information asymmetry and therefore a situation close to a competitive equilibrium) woul d be able

to increase social welfare (de Mendonça and Simão Filho, 2008). Hence, the literature that investi-

gates the relationship between transparency and welfare considers the benefits that private agents

earn owing to better understanding the decision that their peers may take (Morris & Shin, 2002).

Our work makes two main contributions. First, we develop a theoretical model that consi ders

heterogeneous agent (rich and poor) in a shopping‐time economy based on the idea that through

information disclosed by monetary authorities, the public can judge the content and then decide

DOI: 10.1111/rode.12523

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© 2018 John Wiley & Sons Ltd wileyonlinelibrary.com/journal/rode Rev Dev Econ. 2018;22:e202–e227

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the best strategy in order to preserve its resources. One important difference in our model is that

although asymmetric information has a negative impact on both rich and poor, the opacity (lack of

transparency) may worsen income inequality between them. Second, based on the result from the

theoretical model we make an empirical investigation whether an increase in transparency com-

bined with other factors can decrease income inequality through panel data methodology that

draws on 37 developing countries for the period 1992 to 2012.

1

Our empirical strategy relies on three income inequality indicators (Gini index, income share

held by the highest 10 percent, and income share held by the lowest 10 percent) and we build one

indicator for transparency that considers how much the monetary authority is consistent with its

mandate (price stability). Therefore, a key element is to observe how much the monetary authority

deviates from the information regarding the policy objective that the public actually have (implicit

target). Furthermore, in order to give robustness to the results, we also make use of the index made

available from Dincer and Einchengreen (2014), which considers several aspects of transp arency.

In addition, in consonance with the theoretical model, our independent variable of interest in the

analysis is the interaction term between transparency and other factors that can improve the distri-

bution of income. At last, with the intention of eliminating any chance of odds in empi rical analy-

sis, we use three different panel data methods: fixed effects (F‐OLS), difference generalized

method of moments (D‐GMM), and system generalized method of moments (S‐GMM).

Our results contribute to the literature concerning central bank transparency and income

inequality. The findings allow one to conjecture that an increase in transparency combi ned with

other factors can reduce the income inequality between rich and poor. It is important to note that

there exists a growing literature on monetary authority's transparency (or central bank trans -

parency) showing several implications on macroeconomic variables.

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However, the literature that

investigates the influence of the transparency on social issues is too incipient.

3

The first studies on

the influence of transparency in social welfare show that public information, even when its content

is not directly related to economic fundamentals, is able to determine beliefs and actions of eco-

nomic agents.

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The rest of this paper is organized as follows. The next section presents a theoretical model on

the relationship between income inequality and central bank transparency. Section 3 is concerned

with empirical evidence. It describes data, variables, as well as the empirical model. Furthermore,

it provides the estimation results and a robustness analysis, as well as the discussion of our results.

Section 4 concludes the paper.

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A SIMPLE MODEL

The theoretical model in this section is concerned with the idea that a lack of transparency and

thus asymmetry of information can lead to a worsening distribution of income between rich and

poor.

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This model takes into account heterogenous agent shopping‐time economy in which economic

agents present distinct productivities in the production of the consumption good, and differentiated

access to transacting technology. The economy has an infinite number of homogeneous consumer

cohorts (with the same number of consumers) distributed in the interval [0,1]. The productivity of

consumers in cohorts j∈[0,1] is γ

j

> 0 (with productivity nondecreasing in j). Based on a cut‐off

productivity (



j), the classification between poor ðγj<γ

jÞand rich ðγj>γ

jÞis made. Both poor and

rich have access to currency Mbut only rich can use an interest‐bearing asset (X, which pays a

nominal interest rate equal to i

x

) and buy bonds (B, which pays a nominal interest rate equal to i

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