Oct. 10, 2011 Central bankers are right to avoid being completely clear about the state of the economy, according to a game theory expert who has been appointed Professor of Economics at the University of Leicester.
Extolling the benefits of being vague, Chris Wallace, who joins Leicester from Oxford University where he was Professor of Economic Theory, says bank chiefs who provide "something in between full information and no information" on current economic conditions are employing the best tactics to help financial stability.
Professor Wallace explains that if a central banker's views on the economy are too revealing, traders will make the error of blindly following this advice, because they know that it will strongly influence stock markets. As a result, they may neglect very good sources of more private information, such as high-quality reports produced by their own companies.
The end result is that people misprice stocks, because they rely only on one source of information to the exclusion of others. Professor Wallace says the solution is for the central banker to say something about the economy, but not enough to dominate markets. Central bankers are generally wise enough to follow this rule, he adds.
"There's something in between full information and no information -- and there's a benefit to that between-ness. Vagueness has a value," he said.
Chris Wallace's unusual view on the nature of information comes from his study of game theory -- a discipline which started in economics but has since proved useful in explaining why things happen the way they do in fields as diverse as biology and computer science.
Game theory is the science of working out how people act and react to each other in complex situations where there are at least two people involved -- each with their own different motivations and interests.
Prof Wallace says vagueness can be an effective tool in any area of public life where the person giving the information knows that the person receiving it is likely to over-respond to precise information -- as in central banking. But it can also make sense if the person receiving the information is prone to under-respond to precise information -- as politicians sometimes do when they receive figures on pollution from environmental scientists, for example.
Prof Wallace, who was Professor of Economic Theory at Oxford and Fellow in Economics at Trinity College, Oxford before joining Leicester this month (October), says: "What I like about game theory is that it's not straight economics, it's applicable to many other disciplines. It's a tool that an economist might use -- but equally, biologists use game theory. It is applied in a wide variety of places, and I find that breadth exciting."
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