How do central banks talk?

HOW DO CENTRAL BANKS TALK?

Geneva Reports on the World Economy 3

Alan Blinder Princeton University

Charles Goodhart London School of Economics

Philipp Hildebrand Union Bancaire Privée, Geneva

David Lipton Moore Capital Strategy Group

Charles Wyplosz Graduate Institute of International Studies, Geneva and CEPR

ICMB INTERNATIONAL CENTER FOR MONETARY AND BANKING STUDIES CIMB CENTRE INTERNATIONAL D’ETUDES MONETAIRES ET BANCAIRES

About the Authors

Alan S Blinder is the Gordon S Rentschler Memorial Professor of Economics at Princeton University, a partner in the Promontory Financial Group and Vice Chairman of The G7 Group. From 1994 to 1996, he was Vice Chairman of the Board of Governors of the Federal Reserve System. He is the author of many books and articles, including Central Banking in Theory and Practice and the best-selling textbook (with William Baumol) Economics: Principles and Policy. Charles Goodhart, CBE, FBA , is Professor of Banking and Finance at the London School of Economics. He had earlier been a Chief Adviser at the Bank of England and more recently served on its newly created Monetary Policy Committee. He has written numerous articles and books on m o n e t a ry history and policy, including a graduate textbook, M o n e y, Information and Uncertainty. Philipp M Hildebrand is Managing Director and Member of the Executive Committee of Union Bancaire Privée, Geneva. He has previously been a partner at Moore Capital Management and Chief Investment Officer of the Vo n t o b e l Group, and a member of the Executive Board of the Wo r l d Economic Forum. The author of numerous articles and editorials, he is a member of the Economic Policy Commission of the Swiss Banking Association. David A Lipton is Managing Director of the Capital Strategy Group at Moore Capital Management and is based in Washington D.C. He served in the Clinton administration at the Treasury Department from 1993 to 1998 as Under Secretary of the Treasury for International Affairs and before that as Assistant Secretary. Before joining the Clinton administration he was an economic advisor to the governments of Russia, Poland and Slovenia, and served on the staff of the International Monetary Fund. Charles Wyplosz is Professor of International Economics at the Graduate Institute of International Studies in Geneva, Director of the International Center for Monetary and Banking Studies and Co-Director of CEPR’s International Macroeconomics Programme. He currently serves on the French Prime Minister’s Conseil d’Analyse Economique. He has written and edited several books on monetary and exchange rate policies and is the author (with Michael Burda) of a textbook, Macroeconomics: A European Perspective. vii

Contents

List of Conference Participants List of Tables List of Figures List of Boxes Acknowledgements Foreword Executive Summary

xi xiv xiv xiv xv xvii xix

1 Central Banks’ Communication Strategies: Summary and Conclusions 1.1 1.2 1.3 1.4 1.5

The times, they are a changin’… Why do central banks need to talk? What should central banks talk about? How should central banks talk? How do central banks actually talk?

1 2 2 4 6

2 Why do Central Banks Need to Talk? 2.1 2.2 2.3 2.4 2.5 2.6 2.7

Introduction Communication: transparency of the policy regime Economic effectiveness arguments for transparency The case for creative ambiguity Contents of communication Interest rate smoothing Democratic accountability

8 10 11 13 17 18 22

3 What Should Central Banks Talk About? 3.1 3.2 3.3 3.4 3.5 3.6 3.7

Preliminary Talking about objectives Talking about methods Talking about decisions Communicating exchange rate policy: what is different? Maintaining confidentiality Conclusion

27 28 31 36 39 43 43

ix

x

Contents

4 How Should Central Banks Talk? 4.1 The trend towards monetary policy committees 4.2 Communicating the decisions and proceedings of monetary policy committee meetings 4.3 Communicating the central bank’s views of future developments 4.4 Communicating the central bank’s views to the legislature 4.5 How to handle disagreement: collegial versus individualistic policy committees

46 48 52 58 61

5 How Do Central Banks Actually Talk? 5.1 5.2 5.3 5.4 5.5 5.6

The Federal Reserve of the United States The European System of Central Banks The Bank of Japan The Bank of England The Reserve Bank of New Zealand Conclusion

65 71 78 84 88 91

Comments and Discussions 1 Discussion of the report 2 First panel discussion: the art of communication 3 Second panel discussion: the future of central bank communication

93 99 105

Endnotes

111

References

119

Executive Summary

Secrecy is no longer the byword in central banking circles. Now central banks are trying to make themselves understood, and the trend is towards greater openness and transparency. This report describes and evaluates how central banks talk to the markets, to the press and to the public. The case for transparency is based on both policy effectiveness and democratic accountability. Monetary policy is more effective when the central bank is better able to condition the market expectations that are so critical to the transmission of monetary policy. Transparency and accountability go hand in hand with central bank independence – a kind of exchange for the broad grant of authority. The essential message that any central bank must convey to the public is its policy regime: what it is trying to achieve, how it goes about doing so, and its probable reactions to likely contingencies. Of course, no central bank can spell out in advance its reaction to every conceivable contingency; nor is it necessary to reveal every detail of its operations. Two guiding principles apply. First, the bank should reveal enough about its analysis, actions, and internal deliberations for interested observers to see the logic behind each policy decision. Second, the burden of proof should be on those who would withhold information. There are valid reasons for secrecy, but they are the exception not the rule. What should central banks talk about? First, they need to spell out their long-run objectives clearly. This is a simple task for banks with a single target, such as the inflation rate or the exchange rate, a more difficult one for central banks with multiple goals. But they should articulate their aims as best they can. Central banks should also reveal a great deal about their methods – including their forecasts, the models used to derive them and to explore alternative policies, and the precise methods of implementing policy changes. We recommend that central banks reveal at least the broad contours of their forecasts as often as they are made. We reject the old conventional wisdom that central banks should never give ‘forward-looking’ information. Should the central bank publish a c o n d i t i o n a l forecast predicated on u n c h a n g e d m o n e t a ry policy, or base its published forecast on its actual projections of future monetary policy changes? Our pragmatic view is to xix

xx

Executive Summary

acknowledge that central banks typically do not formulate explicit plans for future monetary policy, and so cannot reveal future policy changes. Central banks should provide more information about their internal models than they have historically done. Most central bank watchers only care about the bank’s basic view of how the economy works, however, so well chosen words supplemented by a few key numbers may suffice. When they intervene in foreign exchange markets, the authorities almost always try to catch market participants by surprise, and they rarely reveal how and when sterilized interventions have taken place. Lack of sufficient ammunition (foreign exchange reserves) to affect market behaviour can justify this departure from transparency. By contrast, all decisions about d o m e s t i c m o n e t a ry policy should be publicly announced as soon as they are made, with no informational advantage to select ‘insiders.’ Central banks should also provide indications about their tentative future plans, perhaps through statements about which way they are ‘leaning.’ The precise ways in which a central bank communicates will vary, depending on whether monetary policy decisions are made by a single individual or, as is increasingly the norm, by a committee – and, if by a committee, whether decisions are presented as achieved by consensus (a collegial committee) or by individuals voting their own preferences (an individualistic committee). Policy decisions are usually announced with a brief statement. In the case of a single decision-maker, the statement must explain the reasoning behind the decision. A highly individualistic committee may find it difficult to agree on a statement in short order, but detailed minutes – including the vote – should then be released as soon as possible. In collegial committees, there is room for choosing how much to explain immediately (in the statement) or later (in the minutes). Conflicting signals emitted by committees confuse markets and get in the way of transparency. Committees must strive to convey a consistent message even though transparency of individualistic committees requires that differences of opinion be aired in public. How do central banks actually talk? The report looks at a few prominent cases. ■

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The US Federal Reserve System has changed its communications policies dramatically since 1993 and, while perhaps still lagging behind other central banks, it is clearly moving towards greater transparency. We recommend that the Fed state its objectives more clearly, publish its forecasts and clarify their nature, and offer fuller statements to explain its policy decisions. The new European System of Central Banks’ (ESCB) much criticized communications policy is complicated by its short history, its multinational nature and its confusing ‘two pillar’ monetary strategy. Nonetheless, it is already more transparent than the Bundesbank ever was. We recommend that the ESCB clarify the time horizon for its inflation target, improve its published forecasts and publish minutes.

Executive Summary ■

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xxi

The Bank of Japan (BoJ), having been made independent in 1998, has become much more open than it used to be. We recommend that the BoJ clarify its inflation objective and better explain the reserve-targeting policy regime that it adopted this year. The Bank of England (BoE) adopted inflation targeting in 1992 and became independent in 1997. Both events led to dramatic increases in transparency which, by now, place the BoE near the vanguard. We recommend that the Monetary Policy Committee issue a statement immediately after each meeting and try to limit the multiplicity of alternative viewpoints. The Reserve Bank of New Zealand has been leading in central bank transparency since its 1989 reform. It now even publicly projects its own future behaviour. We can recommend no further steps toward transparency.

Geneva Reports on the World Economy How Do Central Banks Talk? 3

How Do Central Banks Talk? A new policy report from ICMB and CEPR

by Alan Blinder, Charles Goodhart, Philipp Hildebrand, David Lipton and Charles Wyplosz ‘The Geneva reports have quickly acquired an enviable reputation for focussing on important topics, undertaking thorough analysis and drawing innovative conclusions. Not all policy makers will agree with the recommendations, but they will certainly be challenged to re-examine their priors.’ Andrew Crockett, Bank for International Settlements

Not long ago, secrecy was the byword in central banking circles, but now the unmistakable trend is towards greater openness and transparency. This, the third Geneva Report on the World Economy, describes and evaluates some of the changes in how central banks talk to the markets, to the press, and to the public. The report first assesses the case for transparency – defined as providing sufficient information for the public to understand the policy regime – and concludes that it is very strong, based on both policy effectiveness and democratic accountability. It then examines what the content of communication should be and argues that central banks ought to spell out their long-run objectives and methods. It then investigates the link between the decision-making process and central bank communication, drawing a distinction between individualistic and collegial committees. The report concludes with a review of the communications strategies of some of the main central banks. ............................................................................... Order your copy now by completing and returning this form to: CEPR, 90-98 Goswell Road, London EC1V 7RR, UK / Fax: (44 20) 7878 2999. Please send me _______ copies of ‘How Do Central Banks Talk?’ (only £25 each) Total amount (including p&p):__________ [Post and Packing – UK: £1.50 for first report plus 50p for each additional, Europe: £2.50 for first report and 50p for each additional, Rest of World: £4 for first report and £1 for each additional]

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PUBLICATION DATE: September 2001

ICMB INTERNATIONAL CENTER FOR MONETARY AND BANKING STUDIES