Mixed effects of Fed forward guidance and communication obstacles

A paper on "Forward Guidance and Macroeconomic Outcomes Since the Financial Crisis" by the Chicago Fed provides a number of model-based insights into the effects of the Federal Reserve's communication strategy of using forward guidance to shape expectations:

When viewed through the lens of our full-information rational-expectations framework, FOMC forward guidance had mixed effects.

Our model indicates ... expectations of tighter-than-usual policy cost the US economy a decline in the output gap’s trough from −4 percent to −6 percent.

At its August 2011 meeting, the FOMC became more specific about its forward guidance, forecasting that the policy rate would remain at its effective lower bound “at least through mid-2013.” Thereafter, interest rate futures began to indicate that the FOMC’s policy accommodation would last substantially longer; and we estimate that this contributed to a much more rapid recovery in the output gap than would have occurred otherwise.

The paper also neatly sums up the practical communications difficulties encountered by the Fed, or actually any other central bank:

To achieve ... perfect communications, the FOMC and public must share a language rich enough to describe policy contingencies and actions, the FOMC must state its policy choices clearly in that language, and private agents must correctly decode the FOMC’s statements. Communications obstacles could have prevented any one of these three necessary conditions from being fulfilled.

First the situation in which the FOMC found itself in December 2008 was truly unprecedented, so the language needed to describe it to the public was necessarily a work in progress. Second, the FOMC speaks as a committee and not as an individual; and the diplomatic process by which any such committee makes decisions sometimes sacrifices clarity for the sake of consensus. Finally, financial market participants’ primary goal is profit, and they only concern themselves with decoding the FOMC’s “true” intentions to the extent that is serves that goal.

A closer look at negative rates, and lessons learned so far

Panelists at Brookings examined the recent experience with negative interest rates, particularly in Europe, and their possible use in the U.S. The event included prominent economists from European central banks and Wall Street, as well as several academics, and former Fed chief Ben Bernanke.

Once a fantasy of a few academic economists, negative interest rates are now seen as a tool available to monetary policymakers at times of very low inflation. But they remain controversial: are negative rates a prudent and potent response to today’s lackluster economy? Or do they squeeze bank profits and hurt lending, confuse investors and consumers, and smack of desperation?

You can download the presenters' slides and replay the video from the event at Brookings' webpage.

Rethinking Monetary Policy

The Spring-Summer issue of Cato Journal, nearly summarizing the articles first presented at Cato’s 33rd Annual Monetary Conference on November 12, 2015:

Contributors to this volume revisit the thinking behind unconventional monetary policy and the “new monetary framework,” make the case for transparent monetary rules versus foggy discretion, and point to the distortions generated by ultra-low interest rates and preferential credit allocation. In doing so, they consider what monetary policy can and can’t do, what rules could improve the operation of the monetary and financial system, and what steps should be taken to safeguard our property rights in a sound monetary regime.

Recommended summer-holiday reading for monetary policy pundits.

Don't limit public talk as Dallas Fed argues

I disagree more than I agree with the conclusions of an Economic Letter published by the Federal Reserve Bank of Dallas on central bank communication and its need to overcome the public’s limited attention span.

Let's have a detailed look what that paper has to say:

It is critical that central bankers have the ability to communicate their monetary policy goals and intentions involving employment and price stability to the public. The task is complicated in an economy that includes many firms and households in an era of information overload.

This is something I can completely agree with. Communicating on complex matters such as monetary policy is quite a difficult task to accomplish.

Central banks, with the explosion of new media outlets, have more opportunities than ever to provide information, while the private sector must choose from the competing media sources. Thus, for a central bank to remain relevant, it must carefully ponder what to say and whether changes in the economic environment warrant the public’s attention.

Sure, central banks do need to spend time and effort to carefully craft their communication messages, and many of them actually do. Communication is an art, rather than science, and inevitably it takes some practice to learn the craft.

… the central bank should limit communication when both GDP and inflation are stable.

On this, I can't disagree more. Of course!

Not only because that notion is wrong, but also because it appears to be based on a false assumption that the public’s attention remains at an equal level no matter whether times are good or bad. This is a misunderstanding.

In my view, there is no need for the central bank to willingly limit communication when the times are good. To the contrary, the central bank should continue performing as usual even when things stabilise. The rest happens naturally. The media, and the public, logically turn their attention away from the central bank during good times, as monetary policy once again becomes boring. People tend to do so on their own, without any push from the central bank. The public attention, and the visibility and frequency of media reports on the central bank, naturally declines when the economy and inflation are stable. No need to artificially “limit communication”.

Central banks should consider attracting the public’s attention when it matters.

That would require central banks to step up, rather than curb, their communication efforts when conditions worsen. One can completely agree with this part of the conclusion.

What is much more problematic is the final part:

Moreover, a more effective communication strategy for the central bank could be to speak less often and make each speech count by delivering a more focused, cohesive and concise message.

There is no dispute that public messages presented by central banks need to be "focused, cohesive and concise" to enable effective communications. However, adopting a strategy to consciously “speak less often” is undesirable.

By opting to become artificially silent at a particular juncture, a central bank risks creating virtual media reality and fanning speculation that it has something to hide. The risk is that when it chooses to speak again, it creates news — about the mere fact that it is talking, rather than drawing attention to what it is talking about. That is actually the lesson learnt by some developing countries’ central banks in Central Asia and Africa, that withdrawing from the public arena to limit the potential for misinterpretation or miscommunication is ultimately counterproductive.

However inconvenient it is for science-driven researchers to accept, I don't think it is possible to prescribe scientific requirements for good communication. All it takes is to carefully craft messages and painstakingly design communication events, and — sometimes inevitably by trial and error — try to strike the right balance for the frequency and scope of communications at every given point in time.

No scientific, model formula can give an exact recipe for success. As in art, the outcome often depends on factors beyond one’s control. Communicators, as craftsmen, simply need to play it by ear.

Modernized National Bank of Ukraine on transformation of central banking

A recent turnaround has transformed the National Bank of Ukraine from a hotel operator into a central bank. To prove its central banking credentials, the NBU is now organizing a first research conference. Titled "Transformation of Central Banking", the event features a number of high-profile speakers focusing on the hot central banking topics.

The impressive speakers' list includes Riksbank's Deputy Governor Per Jansson, professor of economics at Dartmouth College Andrew Levin, ex-Governor of the Swiss National Bank Philip Hildebrand, former Czech National Bank Governor Zdenek Tuma, and a one-time member of President Obama’s Council of Economic Advisers Maurice Obstfeld.

The NBU has made great strides towards modernizing the central bank over the past few years, and its conference is aimed at helping it find out how a central bank of the future is going to look like.

NBU Governor Valeria Gontareva, giving the conference-opening speech:

Our team has found the National Bank as a huge organization with many thousands of staff, 500 of fleet vehicles, and total of 150 thousand square meters of premises. For decades, the NBU has been overgrowing with extrinsic to central bank functions and assets. The central bank used to own university and academy, TV channel, hotels in resorts areas, hospitals and sports complexes. It performed any function but not a quality central banking.

We started the transformation project in 2014, and it is mostly completed by now. While focusing on basic central bank functions we have disposed of most of the non-core functions and assets. The National Bank is evolving towards the branchless central bank by closing the regional offices and centralizing all key functions in the NBU in Kiev. We have already closed 25 regional branches. At the same time, we’ve also massively optimized the number of staff. In 2014 we had about 12 000 employees, as of the end of 2015 this number was lesser by 55% - 5 300.

Today the National Bank of Ukraine is striving to the best global practices in the area of central banking though they are permanently changing and developing.

The conference is being organized in cooperation with the Narodowy Bank Polski, with the assistance of the Government of Canada and the Kyiv School of Economics.

NY Fed building a free macro model

Macroeconomic modeling is predominantly central banking science, and central banks that publish their models belong to the most transparent in the world.

Now the Fed wants to go even further.

A research team at the New York Fed is part way through translating its DSGE model into Julia, a fast, open-source mathematical programming language.

As reported by, the NY Fed had already published the code underlying its DSGE model, originally written in Matlab, and agreed last year to translate its model for policy analysis into the new programming language:

Marco Del Negro and Marc Giannoni, both assistant vice-presidents in the NY Fed's research department, headed the project. "One of the arguments for going with Julia was it is fairly close to Matlab," says Giannoni. "People who are familiar with Matlab can at least read code written in Julia. There are a lot of subtleties to Julia you must get familiar with, but at least you can get started."

All the code for the estimation step is now available on GitHub, an online repository for open-source code. Anyone can therefore download and run it with only a limited grasp of programming in Julia required. It comes pre-packed with sample dataset and configuration.

By making the model free, the hope is coders will take the model and suggest improvements, so it can evolve over time ... Other central banks and researchers can also take the model and adapt it to their needs, and many have already expressed an interest. "The whole point of putting our code on the web is for others to use it and adapt it to their needs," says Del Negro.

In enhancing central bank transparency by yet another notch, this is an important experiment. As researchers at the NY Fed say: "Now anyone, from Kathmandu to Timbuktu, can run our code at no cost." Still I cannot help but wonder how many people out there is actually going to take the time and make an effort to play with such open-source toy.

How disasters, government spending impact inflation?

Two studies which make for one central banking story on my blog.

Reserve Bank of New Zealand, in a paper on the impact of disasters on inflation:

There is a marked heterogeneity in the impact between advanced economies, where the impact is negligible, and developing economies, where the impact can last for several years.

There are also differences in the impact by type of disasters, particularly when considering inflation sub-indices.

Storms increase food price inflation in the near term, although the effect dissipates within a year. Floods also typically have a short-run impact on inflation. Earthquakes reduce CPI inflation excluding food, housing and energy.

Federal Reserve Bank of St. Louis, in a study devoted to answering the question of how inflation is affected by fiscal policy:

Across the board, we found almost no effect of government spending on inflation. For example, in our benchmark specification, we found that a 10 percent increase in government spending led to an 8 basis point decline in inflation. Moreover, the effect is not statistically different from zero.

Does our finding, by itself, imply that countercyclical government spending is ineffective at boosting output? Not necessarily. Our paper simply demonstrates that the inflation channel of government spending is not an empirically important way that this spending might affect the economy.

A unifying theme of both studies is that the impact on inflation tends to be lower or shorter-lived than one might intuitively expect.

Helicopter Ben delves into helicopter money debate

Ben Bernanke, in a long blog post on the merits of helicopter money as a "presumably last-resort strategy" for policymakers:

"... the probability of so-called helicopter money being used in the United States in the foreseeable future seems extremely low. The U.S. economy has continued to strengthen and is not today suffering from the severe underutilization of resources and very low inflation (or even deflation) that would justify such an approach.

Nevertheless, it’s important that markets and the public appreciate that, should worst-case recession or deflation scenarios occur, governments do have tools to respond. Moreover, with central banks in Europe and Japan struggling to reach their inflation targets, money-financed fiscal actions may receive more attention outside this country.

Remarkable that the former Fed chief seems to be nudging policymakers in Europe and Japan to look more closely into the concept despite, as he says, the imagery of helicopter money being "off-putting to many people".

BoE blog post proves Friedman right

Bank of England, on its Bank Underground staff blog on flexible exchange rate regimes:

When ... using a panel of 180 countries over 1960-2010, I find robust evidence that flexible exchange rates deliver a faster current account adjustment among developing countries.

...flexible exchange rates do deliver a faster adjustment of the current account for developing countries. After all, the data seems to verify the intuition put forward by Freidman more than sixty years ago.

Blog is certainly a great tool for central banks to share results of research like this one.