Fresh contribution to settling “The Inflation Targeting Debate”

The inconclusive debate among academic economists about the merits and macroeconomic consequences of inflation targeting (IT) has just received a fresh impetus that is particularly relevant for developing countries aspiring to adopt IT.

The proponents of IT have argued that enhanced transparency and accountability associated with this monetary policy framework allow IT central banks to more firmly anchor inflation expectations. This is providing policymakers with more room to expand the economy in the face of adverse shocks without jeopardizing the credibility of monetary policy.

A recent IMF working paper, titled “Settling the Inflation Targeting Debate: Lights from a Meta-Regression Analysis”, has offered the following key findings on “The Inflation Targeting Debate”:

“… IT adoption is likely to bear more fruits (price and output stability) when fully implemented in developing countries. Indeed, monetary policy credibility has yet to be earned in these countries, such that a successful implementation of IT may help anchor inflation expectations more firmly and close the credibility gap.

But key preconditions need to be met for IT to yield beneficial effects, including notably sound fiscal positions, deep financial system, and greater exchange rate flexibility.”

A hike in inflation targets seen as a cure for stubbornly low inflation

A group of economists, including former Central Bank of Ireland chief Patrick Honohan, has spoken in favor of raising central banks' inflation targets to meet their price stability mandates and boost their economies.

The latest Geneva Report on the World Economy:

Although policymakers have tools for stimulus at the lower bound, these may not always be enough. We therefore also consider adjusting policy frameworks to reduce the risk that nominal rates hit zero. Of the many proposals out there, the most obvious and simplest of such adjustments would be a modest increase in central banks’ inflation targets.

Perhaps the most common reason that policymakers have resisted raising the inflation target is the concern that credibility will suffer. We believe this concern is unwarranted and misplaced. Central banks should seek credibility for their commitment to meet their ultimate goals – full employment and price stability – not for their commitment to a particular number for the inflation target. A greater risk to central bank credibility may be the protracted inability to meet their mandates at the current low targets, due to the lower bound constraint.

The paper joins a raft of academic publications offering suggestions on how to prevent central banks from becoming increasingly impotent to deliver on their promise to engineer 2 percent inflation when interest rates have reached the zero lower bound.

True that the inability of central banks, in many developed countries around the world, to meet their declared 2 percent objectives poses a clear credibility threat.

Australia's central bank head turns into minimalist speaker

Governor Glenn Stevens chaired his final Reserve Bank of Australia policy meeting earlier this week and gave almost nothing away on the outlook for monetary policy as he handed over to successor Philip Lowe.

Bloomberg neatly summarized Stevens' last policy statement in this chart:

The statement accompanying his decision to keep the cash rate unchanged at a record low 1.5 percent was just 375 words long, the shortest since May 2015.

He’s “effectively leaving a reasonably clean slate” for Lowe, according to Royal Bank of Canada interest-rate strategist Su-Lin Ong.

A good role model for outgoing governors. Don't tie your successor's hands by committing the bank to a course of action you will no longer be part of...

South Africa's communication change aids policy predictability

A recent South African Reserve Bank's (SARB) paper analyzed the impact of change in communication adopted in January 2014 on the predictability of monetary policy by economists and financial market participants.

Throughout 2014 the South African Reserve Bank (SARB) explicitly communicated that monetary policy was on a rising cycle until normalisation is reached.

The results based on descriptive analysis and a nonparametric change points model confirm the influence of the "rising cycle" talk in shaping expectations of both economic experts and financial market participants on the future path of the reaction function of the SARB. Besides the surprise effects of January 2014, agents clearly predicted subsequent rate hikes based on the guidance received from the SARB. Previous rising interest rate cycles do not portray the same degree of predictability by analysts.

The paper bridged the gap existing in literature on the predictability of monetary policy by market participants in South Africa, and provides a useful case study for other countries in Africa and other developing countries seeking to enhance communication on monetary policy.

Transparency helps raise effectiveness of monetary policy – Q&A with Ghana's Governor

New Bank of Ghana Governor, Abdul-Nashiru Issahaku, underscored his committment to enhancing transparency and communication on monetary policy at the BOG in answers to my questions.

This is the third post in what I would like to develop into a series of Q&As on the topics of transparency and communications with leading central bankers around the world.

Prior to Mr Issahaku, I spoke to Czech National Bank Vice Governor Mojmir Hampl and National Bank of Georgia's Vice Governor Archil Mestvirishvili.

I first met Mr Issahaku personally in November last year when he was serving as Deputy Governor. We met again in April this year, by coincidence just a few days before he was appointed Governor. When I visited Accra in July, Mr Issahaku was firmly at the BOG's helm. This was when he agreed to become the third central banker, and the first governor, to answer the set of my questions.

So Mr Issahaku, what is your take on my questions?

Transparency increases effectiveness of monetary policy

What in your personal view is a clear signal of the transparency of a central bank?

Generally, in recent times, central banks are more transparent and accountable to the public but in different ways. To achieve price stability, which is our core mandate, and also sustainable growth in the long term, monetary policy must be conducted in a credible manner; and must be viewed as credible by the public. This way, inflation expectations will be low and the feed-through effect will be a less expected demand for higher wages and prices.

We are conducting monetary policy in a way to reduce inflation from the current level of 16.7 per cent (in July) to the medium-term target band of 8±2 per cent in the third quarter of 2017.

Mr Issahaku speaks at a press conference held at the BOG's headquarters in Accra (photo taken by myself).

Mr Issahaku speaks at a press conference held at the BOG's headquarters in Accra (photo taken by myself).

Also, in the pursuit of our mandate to maintain general price stability, it is just fair, as democratic principles demand, to be accountable, responsive and transparent to the public. Transparency will not only make you more accountable but also increase the effectiveness of policy.

The signal here is that the tight monetary policy stance has led to a drop in headline inflation from 19.2 per cent in March to 16.7 per cent in July. We see this to be an indication of the result of the open and transparent manner through which monetary policy has been conducted.

Central bank communication must avoid creating noise

How much more open could your central bank become? What are the limits on the transparency of a central bank? Where in your view does the transparency of a central bank have to end?

The central bank must, at all times, be accountable. The public, made up of different constituents, would want to know if the central bank is pursuing its mandate the right way. And this must be regularly demonstrated, which means that there are no closed ends to the question of openness or transparency, suffice to say also that in the pursuit of transparency and openness, however, attempts must be made not to create "noise". This is because the noise effect rather creates obscurity and makes it difficult for the public to understand what the central bank is saying. Economic outlook and policy strategy must be transparent and to the extent that the ultimate long term goal is sustainable growth, measures must aim at galvanizing public support for policy, and transparency can promote this.

Central bank communication message need to be consistent

What have you found to have been the most difficult moment in your central bank’s efforts in communications in recent years? What was the lesson learned?

There are never easy periods in central bank communications, except that whenever there is transparency, supported by a strong view of the independence of the central bank by the public, expectations are managed. When expectations are managed through these dynamics it makes it easier for policy stance. It is therefore all about the message and how it is delivered - and its consistency too.

Aside monetary policy, like all central banks, there are other responsibilities too, such as the oversight of the banking system- regulations and supervision. The public, for instance, would want to see that the central bank’s claim about the soundness of the financial system or about a particular institution is exactly what it is. So there is the conventional monetary policy, which may involve communicating the inflation target in an effective way, and the other responsibilities that may also require a significant level of public support for policy measures. The difficulty will only come when the communication strategy is not well thought through.

I must add, in conclusion that we are continually, like all central banks do, adding to the tools and instruments that would make our communication even better.

Clear central bank communication needed to reduce uncertainty

How important is communications to your central bank’s current policy? What is the biggest challenge in your communications at the moment?

Monetary policy communication aims to help educate the public about key economic concepts, Bank of Ghana’s mandate and policy objectives, the importance of achieving low inflation for long-term growth and the value of a transparent and operationally independent central bank. The strategy recognises that a proactive effort, transparency, and clear explanatory communication are required to win public support for the conduct of monetary policy under inflation targeting.

Also, other communication strategies have been identified as though non-specific to communicating monetary policy but are still dynamic factors that have impact on harnessing support for monetary policy stance. In some countries, especially in developing ones where information asymmetry is a big problem, there is the need for central banks to push harder with consistent messages that would shape behaviour so as to achieve the desired outcome.

Clarity reduces uncertainty by helping stakeholders anticipate central bank actions. To influence economic growth and inflation, greater clarity is what is needed, and not less of it!

I believe that central banks must work to ensure that the public understands monetary policy decisions and actions taken, to ensure that the financial system is sound at all times. As we roll out the current communication plan, l am sure these challenges would be surmounted.

All stakeholders need to have good understanding of central bank job

Who are the most important stakeholders in the communications of a central bank?

We have identified the following stakeholders in our communications strategy: The general public, financial markets, opinion leaders in academia, think tanks, the media, parliament and of course staff of the Bank. It is critical that all stakeholders have a good understanding of the central bank’s mandate, policies and activities.

New Zealand halts embargoed monetary policy communication lock-ups

The Reserve Bank of New Zealand has officially called an end to its practice of announcing monetary policy decisions via embargoed lock-ups.

The decision to stop providing media with pre-announcement access to this market sensitive information under embargo in the lock-up arrangement follows the credibility-damaging leak of the RBNZ's rate cut decision earlier this year.

Announcing monetary policy decisions via embargoed lock-ups inevitably involves risks

As demonstrated by a recent technical glitch in the Fed's lock-up room, central banks' embargoed lock-ups are inevitably prone to error, and the only prudent strategy is to keep the oversight of the embargo procedures ultra tight.

From this month, the RBNZ introduced new procedures for monetary policy releases, calling for the policy decision to be announced simultaneously via its pages on Bloomberg and Thomson Reuters terminals, the Bank’s website, Twitter, and email to news media and general public subscribers. The RBNZ commissioned a communications security review by Deloitte, which suggested the Bank discontinue the lock-up arrangements unless it is prepared to take some risk and invest heavily into a secure controlled computer environment.

Governor Graeme Wheeler, in an RBNZ press release:

"The review found that in the rapidly changing technology environment there is no completely failsafe option, and that over time the extent of risk mitigation through controls will be eroded by advances in technology.

"We gave serious consideration to the value of the lock-ups, and the potential issues that could arise if we permanently discontinued them. We also consulted with many other central banks. New Zealand was one of only a few central banks that held pre-release lock-ups of OCR decisions for news media."

True, as I have argued on this website earlier, it takes effort and costs money to keep lock-up embargo rules ultra tight and review them regularly along with advances in technology. The RNBZ's communications security analysis serves once again to reinforce this point.

Youngest regional Fed president adapts central bank communication to social media

Neel Kashkari, President of the Federal Reserve Bank of Minneapolis, is adapting what most of the public views as oft-quirky central bank talk to the social media age.

As reported by Bloomberg:

"For 30 years, or maybe longer, the Fed had adopted this Wizard of Oz posture, that we’re so mysterious, we’re so powerful, don’t ask any questions."

"At the end of the day, we’re here to work on behalf of Main Street."

Kashkari, at 42 the youngest regional Fed bank president, has frequently used his Twitter account to post quick comments and respond to questions.

Recently he set a new communication standard for central bankers by adding an inflation-target emoji to one of his posts:

Exception to the rule? Rare public town hall forum with a central banker

Minneapolis Fed President Neel Kashkari held a public town hall forum making himself freely available to asnwer questions about the risks big banks pose, the economy and the role of the Federal Reserve.

The invitation read as follows:

Learn more about Kashkari's major initiative to end the "Too Big to Fail" problem and ask questions about the risks big banks pose, the role of the Federal Reserve, and what the Minneapolis Fed plans to do to address TBTF.

One can listen to an audio file of the event on the Minneapolis Fed's website.

Organizing a free public town hall forum is extremelly rare within central banking circles. As far as I could count, there was just a handful of such events in recent years.

Kashkari has been probing frontiers of central bank communications with his proactive drive to reach out to the general public. That's an approach that central banks in many developing countries may want to consider following to help get their message out.

Behind the scenes of a policy decision and communication

The Reserve Bank of New Zealand published an article providing a behind-the-scenes look at how the central bank reaches a policy decision and communicates it via a Monetary Policy Statement.

A useful, detailed explanation of the state-of-the-art monetary policy decision-making process at a leading inflation-targeting central bank.

A clear consensus on how a central bank should make decisions ... is yet to emerge amongst academic economists, but inflation-targeting central banks have adopted some common features in their decision making.

These common features include policy discussion within a committee, considering of a wide set of information, a focus on transparency and clear communication to stakeholders, and generally modest moves in policy settings that are regularly reviewed.

On the purpose of designing robust decision-making arrangements, the RBNZ - in an apparent move to regain confidence after an embarrassing, reputation-hurting news leak in March - said:

The Bank’s monetary policy decision-making process is designed to: reduce uncertainty as much as possible; characterise the uncertainty that remains; help decision makers understand and balance the consequent risks; communicate the decision, underlying judgements and risks externally; and ensure that the Bank’s policy stance and judgements are constantly reviewed in the face of new developments.

A glitch at another central bank lock-up

One, unnamed, media organization released news about Federal Reserve's June minutes ahead of embargo because of a technical glitch in the Fed's lock-up room. The bug caused other media to report on the minutes with a delay.

Analysts quoted by The Wall Street Journal described the error as significant in an age of near-instantaneous electronic trading:

The Fed didn’t name the news organizations affected by the error Wednesday, but they included The Wall Street Journal and Dow Jones Newswires. Transmission of Dow Jones & Co.’s journalists’ headlines and news articles, scheduled for release at 2 p.m. EDT, was delayed by about 40 seconds, according to Dow Jones & Co. data. The Fed didn’t disclose how much earlier before 2 p.m. one organization was able to transmit its report.

Seems like central bank lock-ups - arrangements designed to provide media with access to sensitive information under embargo - are inevitably prone to error, and the only prudent strategy is to keep the oversight ultra tight.

The good thing about the latest indcident at the Fed is that the US central bank swiftly made a transparent statement admitting and explaning the embargo break:

A technical error occurred Wednesday during the media lock-up for the release of the minutes of the June meeting of the Federal Open Market Committee. As a result of the error in the use of the Federal Reserve equipment that cuts off and enables electronic access from the media lock-up room, one media organization informed us it prematurely transmitted some embargoed information. Our technical error also resulted in some media organizations experiencing a delay in their ability to transmit information.

At the core of this latest central bank embargo break was a technical glitch, and not a human error, which stood behind the credibility-damaging leak of the Reserve Bank of New Zealand's rate cut decision earlier this year.

As I argued on this website earlier, any embargo rules must be kept ultra tight and be reviewed regularly along with advances in technology. The lock-up error at the Fed serves to reinforce my point.