Does the Federal Reserve Possess An Exploitable Informational Advantage? Does the Federal Reserve Possess An Exploitable Informational Advantage?

Revised article published in Journal of Money, Credit and Banking vol. 35, no. 6, part 1 (December 2003): 931-946.

This paper provides evidence that the Federal Reserve has an informational advantage over the public that can be exploited to improve activist monetary policy. The informational advantage derives from the Fed?s role as a bank supervisor, and it is shown to be of sufficient duration to be effective in guiding activist monetary policy, even in simple rational expectations models. The informational superiority does not result from the Fed having earlier access to publicly released data about the financial condition of banks. Instead, this informational advantage is generated by confidential supervisory knowledge about troubled, non-publicly traded banks. As a result, this information can remain confidential for an extended period of time because these banks do not have an incentive to fully disclose publicly the extent of their financial troubles, and, since they are not publicly traded, are not required to do so. The improvement in forecasts using this confidential information is both statistically significant and economically important, providing a potential justification for activist monetary policy.