Central bank transparency and communication revisited What can

Central bank transparency and communication revisited What can we learn from the financial crisis ? Bernhard Winkler European Central Bank Policy session on central bank communication, “New challenges to central banking in the global financial system” Namur, 11 -12 June 2009 Views expressed are not necessarily those of the ECB

Outline • Transparency, clarity and communication (revisited) • Communication and the ECB’s monetary policy strategy • Lessons from the financial crisis ?

Why transparency ? • Independence and accountability • Rise of direct inflation targeting (vs. intermediate target strategies) • Increased role of financial markets • “Managing expectations” (Woodford) • General presumption: more information better (market efficiency) ð monetary policy effectiveness / credibility ?

PART I Transparency, clarity and communication: Dimensions and trade-offs Cf. Winkler (2002), ECB Working Paper No. 26

Dimensions of “transparency” (A differentiated view) • openness • clarity • common understanding ð disclosure of information ð process, simplify and interpret info. ð “shared” interpretation

Transparency in the literature Informational assumptions: SENDER: Central Bank Information • CB incentives to exploit info. asymmetries (Barro. Gordon model) RECEIVER: Public • Know “too much” (CK, rationality, Bayesian uncertainty, homogeneity) • Know “too little” (multiplicity of eq. ,

Monetary policy strategy and communication: The transparency triangle OPENNESS CLARITY (EXTERNAL COMMUNICATION) INFORMATION EFFICIENCY (INTERNAL COMMUNICATION) • Examples: monetary targeting, inflation forecast targeting • Common understanding alleviates the trade-offs • Strategy as “common language”( three Cs)

Monetary policy strategy and communication: The clarity triangle CLARITY OF OBJECTIVE ECONOMIC ASSESSMENT POLICY / INCLINATION • Example: different interpretations of inflation targeting: target rules vs. instrument rule • Example: different roles of inflation forecasts (policy input/output) vs. communication on forward policy

PART II Monetary policy strategy as a framework for decision-making and communication: the example of the ECB

Role of strategy for communication Definition of the objective Internal aspect Decision making External aspect Communication

Primary objective of price stability monetary policy decisions Economic Analysis crosschecking Monetary Analysis Economic information

Definition of price stability • Aim at year-on-year increases in the HICP for the euro area of below but close to 2% • To be maintained over the medium term • Anchor for price expectations • Yardstick against which Eurosystem can be held accountable • Precludes prolonged inflation or deflation, but not imply “mechanical” policy rule

Role of staff projections himportant input in policy decisions h. Conditional projections, not forecasts h. Assumptions, models and staff expert judgement h. Staff responsibility, not “owned” by the Governing Council h. Avoid “self-fulfilling prophecies”, circularity h. Not a “sufficient statistic” for policy decisions

Why two pillars? • Considerable model uncertainty about the structure of the economy • Role of money and financial variables difficult to capture/integrate in mainstream models • Prominent role for money underpins mediumterm orientation • Money and credit expansion also often associated with unsustainable asset prices / financial imbalances (leaning against the wind ? ) • Diversified approach through cross-checking between “pillars” improves robustness (e. g. post-2003 and Dec. 2005, financial crisis)

Features of the ECB’s strategy • Quantitative definition of objective… but no precise point target or fixed horizon • Two pillars take into account all information… but no unstructured “look at everything” • No commitment to simple rule… but systematic rule-based framework (“procedural rule”) • Strategy relatively complex… but: so is reality

Transparency and predictability • Should monetary policy be boring (M. King) and predictable? • Markets reacting to data vs. reacting to CB communication • Could CB communication crowd out private signals (Amato-Shin) • Collegiate vs. individualistic committees • Relevant horizon (preparing markets vs. “systematic” policy over medium-term)?

Communication on “forward” policy Fed experience • Policy directive vs. balance of risks • Standardised vs. ad hoc language (“considerable period”, “patience”, “measured pace” … 2003 -2004 episode) “more detailed language has considerable advantages over simple, discrete categorisation of risks” “Some information unavoidably gets lost when the central bank tries to describe [those] views with a simple summary, like a balance of risks assessment, a point forecast, or a brief statement” “market participants in some circumstances will not recognise the conditionality of the outlook” “difficult to get a committee with diverse views to agree on a detailed statement” (Kohn und Sack, 2003) • Publication of longer-term FOMC

Publishing the “forward” policy path - the last frontier of transparency ? Championed by Woodford & Svensson; pioneered by NZ, NOR, SWE • Persistent deviations of market expectations from published paths (Central banks leading or following market expectations ? ) • Continued episodes of policy surprises • How deal with policy disagreements ? • May forward communication unduly condition policy choices (esp. in crisis context) ?

PART III (Tentative) lessons from the financial crisis ?

Lessons on pre-crisis period (I) communication • CB communication crowding out private information (Amato-Shin) ? • “Excessive transparency” contributing to underpricing of risks by markets (Ferguson) ? • “Excessive credibility” of monetary policy contributing to moral hazard and asset price boom (“Greenspan put”, M. Miller) ? • Role of communication (“measured pace”, Fed, “credible alertness”, ECB) and predictability in conditioning gradual withdrawal of policy accommodation (20032007) ?

Lessons on pre-crisis period (II) strategy • Inflation targeting necessary but not sufficient: move to “intelligent” IT and longer time horizons (J. Gieve) ? • Were interest rates “too low for too long” (M. King) post 2003 ? • Need to pay closer attention to money, credit and sectoral balance sheets/flow-of-funds (M. King, P. Tucker) • Reverse Greenspan doctrine on asset prices: “can’t lean” (against the wind), “can clean” (up after the bubble), Bill White (BIS) ? • How take into account asset prices in inflation targeting (SWE, NZ) ? • Enhance further the broader based approaches of ECB’s two-pillars and Bo. J’s “two perspectives” ?

Lessons on crisis period (I) (general) communication • Under increased uncertainty: clear CB communication more important … but more difficult (unforeseen contingencies / consensus building)! • ECB mantra: “never pre-commit” and “always do what is necessary” • Focus on medium term objective is key to avoid trade -off (long-term) credibility vs. (short-term) flexibility • Central banks as “anchor of stability” and anchor for inflation expectations • Key role of confidence and expectations channel (self -fulfilling feedback loops; role of projections ≠ forecasts) • Communicate uncertainty of assessment but avoid central bank communication becoming itself source of uncertainty

Lessons on crisis period (II) (specific) communication • Communication/ commitment on future policy as (additional) policy tool at zero lower bound ? Credibility of price level targeting (Woodford/Svensson) ? • Hierarchy of communication on monetary policy and non-standard measures: separation vs. integration ? • Communication on non-standard measures: enhanced credit support (ECB), credit easing (Fed), QE (Bo. E) • Communication on money and non-standard measures: as additional policy instrument (≠intermediate target ? ), i. e. “printing money” (M. King, Bo. E) vs. CB balance sheet (Fed, Bo. J) and focus on specific credit markets (Fed) • Interaction of communication on future policy and non -conventional measures (e. g. Riksbank bringing

Lessons on crisis period (III) strategy • Switch to price level targeting to implement optimal monetary policy rule (Woodford/Svensson) at zero lower bound ? • Mainstream New Keynesian (DSGE) models irrelevant for central bank policy during crisis (Goodhart, Buiter) ? • Renaissance of money and credit during crisis ? E. g. Bo. E and discussion at Fed about re-introducing monitoring ranges for monetary aggregates (FOMC minutes, February) to gauge CB balance sheet expansion but also reflecting concerns over need for medium-term anchor and exit strategy

Lessons on crisis period (IV) independence and mandate • Boundary and linkages between monetary and financial stability ? Role of central banks in financial stability / ESRC ? • Central bank independence and the boundary between monetary policy and fiscal policy in context of non-standard measures (Volcker, Buiter) ? • Central bank independence from financial markets as important as political independence (Blinder)

Conclusions • Transparency is about effective communication • A monetary policy strategy provides a framework for credibility, consistency and continuity in (internal and external) communication • The ECB’s institutional set-up, its strategy and communication – while more complex – has proved robust in the crisis