Central banks' communications
In the Second World War a poster with the slogan "loose talk can cost lives" was seen everywhere. Central bankers should perhaps reproduce this poster and paste it on the walls of their inner sanctums. This week a bit of loose talk from Huw Pill, chief economist of the Bank of England (BoE) had an almost instant market effect. Pill said market expectations of cuts in interest rates from next summer were not unreasonable. The yield on the government two-year bond fell to 4.62%, its lowest since June; that of the 10-year bond slipped beneath 4.27%, the lowest since September; the Pound weakened against the Dollar. Perhaps Pill should have consulted with his boss, Andrew Bailey, the BoE's governor, before he made his 'not unreasonable' comment. Bailey has now said that any talk of interest rate cuts is premature: "We are saying policy has to be restrictive for an extended period." This kind of communication confusion can give central banks a bad reputation.
UK Interest rates since April 2022
Ben Bernanke, a former chairman of the US Federal Reserve, once said "monetary policy is 98% talk and only 2% action." but added "the cost of sending the wrong message can be high." The cost of sending muddled messages is no less high.
The perils of forward guidance
Once upon a time monetary policy was set by central banks adjusting interest rates, putting them up if the economy was running hot and inflation started to appear, or down when the economy slowed and recession, with low growth and job losses, became likely. That simple state of affairs came to an end in February 2000, when Alan Greenspan, another former Fed chairman, led the FOMC (the Federal Open Market Committee, which sets interest rates) along a new path, the regular issuing of 'forward guidance' in its policy statements. Forward guidance back then referred to an assessment of the balance of risks facing the US economy. The minutes of the FOMC were a secret until the late 1960s and then only released after a 90-day lag.
Like most things however forward guidance has far expanded beyond its origins and today is a more general prognostication about the economic future. The Great Financial Crash of 2007-2009 gave an impetus to forward guidance. Today the Fed publishes a policy statement immediately after each FOMC meeting and publishes the minutes of those meetings three weeks later. Some welcomed this change as a move towards greater transparency.
But on the other side of the coin, giving forward guidance now lacks the kind of centralized control that once made it meaningful. When different central bankers speak differently about the future path of monetary policy (such as Pill versus Bailey) which is to be believed? Moreover, apart from aiming to get inflation to 2% a year, we have no clear idea what our central bankers are trying to achieve. The US Fed has a clear dual mandate, to create economic conditions that achieve both stable prices and maximum sustainable employment. But what are "stable" or "maximum sustainable"? We are not told, perhaps because, as Tom Barkin, president and CEO of the Federal Reserve Bank of Richmond, has said: "The higher the level of specificity, the higher the risk that you'll bind yourself to a less than optimal path." "Cleanly executing communication is my goal" he says.
Central bankers have tired of forward guidance. The current Fed chairman, Jerome Powell, said at the press conference following the July FOMC meeting that the FOMC will make decisions "meeting by meeting...and not provide...the kind of clear guidance" it used to give. Simultaneously Christine Lagarde, president of the European Central Bank (ECB) said her bank would be ditching forward guidance, in an effort to give the bank the sort of flexibility it needs to adjust monetary policy based on fresh data.
But the genie has long been out of the bottle. Economists, financial media, banks, investors, have all become used to the drug of forward guidance. They imagine that commentaries by central bankers can help cut through the background noise of the markets and central bankers perhaps enjoy the kind of attention their loose talk brings them. They may not know the future shape of the economy but that won't stop them pretending that they do. We all need clean communications; perhaps the cleanest of all are no communications tied to the kinds of moving targets that comprise an economy - any economy.