The way central banks communicate has shifted dramatically since the financial crisis. Gone are the days when policy announcements would come as surprises. Now the world’s main monetary authorities go out of their way to telegraph their next steps to investors. Central bankers hope that better guidance can reduce volatility and even offer extra stimulus when interest rates are stuck near zero.
But is talking to investors enough? At a time when technocrats find it hard to maintain people’s trust, central bankers should seek ways to leave their comfort zone and talk directly to the public. The effect would be protecting their much-coveted independence and — perhaps — making their policy more effective.
At a recent conference held by the European Central Bank in Frankfurt, the ECB’s Michael Ehrmann showed how pervasive the change in central bank communication has been. In a survey of 55 central banks, more than half of the respondents said they had adopted some form of forward guidance on the direction of monetary policy. Ehrmann also showed that some forms of forward guidance had been effective in reducing bond-market volatility after a policy announcement: When central banks clarify their thinking over time, investors don’t need to react as much when a decision is actually taken.
This isn’t the only benefit of forward guidance. In theory, a promise to keep interest rates low for a prolonged period of time — as the ECB itself is doing — is a way to provide stimulus to the economy when the central bank can’t cut interest rates further. The central bank pledge should give families and businesses the confidence to borrow more, as they need not fear interest rates will go up soon.
This second hypothesis has proven more controversial, however. At the same conference, Mario Draghi, the ECB president, said the central bank’s guidance has been “successful” — for example, in keeping financial conditions in the euro zone loose while the U.S. Federal Reserve began to tighten its monetary policy. Others are more skeptical: Central banks have typically adopted forward guidance alongside other policy instruments, such as asset purchases or negative interest rates. It’s possible that actions mattered more than words.
There are also questions about whether forward guidance may prove dangerous in the future. Since central banks pledged they will only raise rates slowly, inflation has been stubbornly low, making it easier for them to stick to their pledge. What if, however, price pressures were to reappear all of a sudden? Market calm could easily turn into mayhem. As Hyun Song Shin, economic adviser at the Bank for International Settlements, said in a speech, “Predictability and gradualism may not be a virtue if market participants take them as a commitment not to pull the rug from under their feet while they build up leverage.”
“How much” isn’t the only question facing central bank communication, however. Just as relevant is the issue is of who the monetary authorities should be speaking to. A striking aspect of the ECB conference was that most senior central bankers present seemed to imply their outreach mainly targeted investors and the specialist press. Mark Carney and Andrew Haldane of the Bank of England were the main exception. As Haldane put it, “The general public are the ones that matter. They are the ones whose trust we need to recapture.”
The Bank of England is going a long way to talk directly to citizens. Its flagship “Inflation Report” — the quarterly document containing the bank’s forecasts — is now accompanied by simple graphics. Bank officials routinely go to schools in a push to explain from early on the virtues of price and financial stability. Other central banks, such as the ECB, also strive to talk to a broader audience — for example, by releasing video games about monetary policy.
These efforts clearly face steep challenges. Central banking is a highly technical matter, which is hard to explain to the public. The financial crisis has reduced trust in economists and technocrats, who are seen as responsible for surging unemployment and stagnating incomes. Central bankers are typically selected on the basis of their understanding of economics and may not have the necessary skills to talk to a broader audience. Finally, in the euro zone, the ECB faces the challenge of having to speak to 19 member states, facing very different economic conditions. National central banks may make the problem worse by contradicting the ECB, rather than defending its positions.
Still, retreating from openness would be far worse. Central bankers care deeply about their independence, which allows them to take unpopular decisions such as raising interest rates to avoid the risk of price and financial instability. Unaccountable central banks are far likelier to face challenges to their independence, and communicating directly to the public is one way to protect it. Clearer communication to the public can also make monetary policy more effective. Were the central bank to use social media to inform the public that interest rates will stay low for some time, it’s possible that some consumers would be more relaxed about spending.
There should be no doubt: Good communication is no substitute for good policy. If a central bank fails to maintain price and financial stability, no Facebook or Instagram post will save it. However, provided the policies are right, it is best to talk about them — to experts and beyond. The post-crisis communication revolution of central banks should continue.