As policy normalizes, Czechs re-publish numerical exchange rate forecast

Exchange rate forecast:  The confidence intervals of the CZK/EUR exchange rate forecast reflect the predictive power of past forecasts (from the period before exchange rate commitment). They are symmetric and linearly widening.

Exchange rate forecast: The confidence intervals of the CZK/EUR exchange rate forecast reflect the predictive power of past forecasts (from the period before exchange rate commitment). They are symmetric and linearly widening.

The Czech National Bank (CNB) resumed the publication of a numerical exchange rate forecast in the form of a fan chart in a move that it said was part of the normalisation of its monetary policy.

This re-establishes an extraordinary level of forecast transparency which was temporarily curtailed in late 2013 as a result of an out-of-the-box policy decision. Now the Czech central bank returns to the practice launched in 2009 when it became the world's only central bank to publish forecasts for the nominal exchange rate against a specific currency in numerical form.

As heralded in my January Q&A with Jan Filáček, my former colleague and Deputy Director of Monetary Policy and Fiscal Analyses Division at the CNB’s Monetary Policy Department, a smooth exchange rate forecast re-launch had been foreseen by Czech central bankers.

In a box included in this year’s first Inflation Report and titled “Return to the publication of numerical exchange rate forecasts” , the CNB wrote:

The actual exchange rate usually deviates from the forecast, sometimes significantly (CZK/EUR)

The actual exchange rate usually deviates from the forecast, sometimes significantly (CZK/EUR)

Although the exchange rate forecast may not materialise, it gives market participants a guide to the future monetary policy stance.

With knowledge of the exchange rate that the central bank uses in its forecasts, they can better assess how new information affects the balance of risks to the forecast. As a result, they can better understand the Bank Board’s decisions. For example, if the exchange rate is appreciating faster than forecasted but the prediction is materialising in all other respects, it is likely that the central bank will compensate for the greater tightening of the monetary conditions via the exchange rate by tightening policy less via interest rates. If the markets take this into account, their expectations of future interest rate growth will be lowered, which in turn will lessen the rate of appreciation. Therefore, publication of the exchange rate forecast by the central bank has a stabilising effect. This is ultimately beneficial to the whole economy.

The Czech experience of gradually increasing, and in the case of the exchange rate forecast even temporarily decreasing, forecast transparency offers plenty of food for thought to central bankers from low income and other developing countries that are modernizing their monetary policy frameworks.

Future of monetary policy communication: Open, clear, explanatory, and aimed at public

Alan S. Blinder, a Princeton University scholar and former Fed official, has made a couple of predictions on the future of monetary policy communication for the next few years. His academic account to a large extent fits my perceptions of the general trend in central banking communication, based on my practical experience with central banks modernizing their policy frameworks. Below I quote, and comment on, two of the Blinder’s six predictions.

Blinder’s prediction # 1: Transparency about monetary policy will increase over time.

Blinder: “I feel confident in predicting this as a generic statement, although the pace and details will vary from one central bank to the next. After all, some are extremely transparent already, while others are less so. But virtually all central banks have been moving in one direction in recent decades--toward greater openness--and I don’t believe that process is over. This prediction derives in part from pretty strong historical evidence that transparency is a one-way street: Once a central bank moves toward greater transparency in some dimension, it never reverts back to its old, less-transparent ways.”

My comment: There is indeed a global trend among central banks towards greater openness, and it is particularly visible in currently less transparent central banks of many low income and developing countries. As soon as a central bank modernizes and aims to become more forward-looking in policymaking, increasing policy and economic transparency becomes necessary. The only detail I would dispute is that there “never” is a way back once a central bank opens up. As illustrated by the recent case of the Czech National Bank, a temporary restriction on transparency, at the very least, remains a viable option at policymakers’ disposal should they decide so in the interest of their policy effectiveness.

Blinder’s prediction # 4: Central banks will keep trying to communicate with the general public, as they should. But for the most part, they will fail.

Blinder: “Much as we may believe that an independent central bank in a democracy should communicate with the citizenry, only a tiny fraction of the citizenry will tune in … You speak one way if you are addressing experts who understand the jargon and dote on every word, quite another if you are talking to members of the broad public who lack both expertise and interest and who are half-listening at best. I am a big believer in democratic accountability, which requires communicating with the broad public. But in truth, the part of central bank communication that matters most is the way policymakers communicate with markets—and for a simple reason: Market participants listen.”

My comment: Here Blinder has a point. As marketing guru Seth Godin has put it, nowadays “there's so much noise, so much clutter... that hoping that (people will) listen closely and carefully enough to figure out what you mean is a recipe for frustration.” And Godin offers a simple alternative: “Maybe, instead of insisting that people listen more closely, you could speak more clearly.” This is exactly what most advanced central banks, with those less advanced in their wake, have been painstakingly striving for: Use as plain and clear language as possible to explain themselves. As Blinder concludes: “It’s high time that central banks, which have travelled a long way down the communications road already, cease viewing words as scarce commodities to be given only grudgingly. Montagu Norman was wrong; they should explain.” Indeed, gone are the days of Montagu Norman, the Governor of the Bank of England from 1920 to 1944, who is often cited as saying that the role of a central banker was: “Never explain, never apologize”.

Blinder made the predictions in a paper titled “Through a Crystal Ball Darkly: The Future of Monetary Policy Communication”, prepared for the Annual Meetings of the American Economic Association, Philadelphia, January 6, 2017.

A smooth FX forecast re-launch foreseen — Q&A with Czech central bank expert

The Czech National Bank has long been seen within the central banking community, and in markets at large, as a prime example of an inflation targeting central bank using consistent macroeconomic forecasts to guide expectations. Gradually increasing transparency and developing elaborate communications has been critical to broadening understanding and gaining credibility for its forecasts, and policy. By 2009, the CNB had completely opened up and provided full forecast transparency, publishing not only the projections of inflation and other key economic variables but also the forecast-consistent trajectories of interest rates and the exchange rate.

It was not a smooth sailing all along, and — in an exceptional move for one of the world’s most transparent central banks — the CNB cut back on transparency and ceased the publication of the FX path in 2014. By removing the FX path from the public domain the Czechs defied the argument that when a central bank opens up, there is no way back. Sure, each incremental step in increasing transparency needs to be carefully thought through. Still, I cannot help but conclude that the Czech example seems to be proving that there indeed is a revolving door for transparency to go back and forth under certain circumstances — a case illustrated by the CNB’s readiness to re-publish the exchange rate forecast from February 2018.

Jan Filáček © CNB

Jan Filáček © CNB

With that in mind, I asked Jan Filáček, my former colleague from the Czech National Bank who recently represented the Bank at the European Central Bank’s communications conference, to evaluate the Czech experience in gradually increasing economic and policy transparency. As Deputy Director of Monetary Policy and Fiscal Analyses Division at the CNB’s Monetary Policy Department, Jan has long been involved in designing the CNB’s transparency and policy communications practices. This post is another in a series of Q&As on central banks' transparency and communications that I keep running on

The Czech National Bank has followed a gradual approach to increasing economic and policy transparency. In 2002, it first published a model-based unconditional medium-term projection of inflation, while providing only verbal comments about future movements in interest rates. What were the most important lessons learned at the beginning of this process of gradually opening up?

The process of increasing central bank transparency is gradual by its nature. It is similar to a child growing up. The kid needs to start with small steps before being able to run. After each improvement, a central bank has to evaluate the outcome and carefully analyze whether the observed benefits have indeed exceeded the costs. Also, central bankers have to get used to each newly introduced communication tool in order to use it properly. In the same vein, the audience – financial analysts, journalists, and broad public – are only gradually becoming accustomed to novel ways of central bank communication.

As you mentioned, we started using the so-called unconditional forecast in July 2002. Before that, the CNB assumed that interest rates will remain stable on the whole forecast horizon. This unrealistic assumption was therefore replaced by the so-called reaction function. This function captures the observed behavior of the CNB, which reacts to forecasted economic developments by changing its instrument, the 2-week repo rate. This very short-term interest rate consequently transmits to market interest rates, proxied in the model by 3-month PRIBOR rate.

The trajectory of 3M PRIBOR rate consistent with the forecast was initially made public in a qualitative manner only, i.e. future interest rate movements were described verbally. The decision not to publish the numerical trajectory of interest rates was then driven by our fears that the published trajectory might be perceived as our commitment to future interest rate changes and that the market might over-react to such communication.

Since 2002 we have continuously educated the public by revealing the assumptions, risks, and uncertainties surrounding each forecast, emphasizing that new information on the domestic and global economy obtained after the forecast is drawn up can change the interest rate outlook. We also stress the fact that the forecast is prepared by staff members, and the Bank Board does not necessarily have to agree with the forecast on each occasion.

The CNB was the first emerging market IT central bank to reveal a forward path for interest rates as a signal regarding future policy. What were the pros and cons of this move weighed at that time?

At the beginning of 2007, only two central banks in the world were disclosing their interest rate forecast – the Reserve Bank of New Zealand and Norges Bank. Sveriges Riksbank started revealing interest rate forecasts in February 2007, while a few others (Bank of England, European Central Bank) were using market expectations as a proxy for future monetary policy decisions. Therefore, the foreign experience was rather limited and only partially relevant for the Czech economy, which was still catching up with the developed economies and had a relatively less advanced financial market.

Only in late 2007, five years after the release of the first unconditional forecast did the Board decide that the CNB could fully reap the benefits of going public with a numerical trajectory of interest rates while avoiding potential pitfalls. The first interest rate path was published in February 2008.

The main benefits of publishing the interest rate forecast were considered to be the greater predictability of the CNB’s decisions and enhanced understanding among financial professionals of how the CNB reacts to different types of shocks. Greater predictability should result in the increased impact of monetary policy decisions on longer-term interest rates, the lower volatility of long-term interest rates, and a decline in risk premia.

The major risk was that the interest rate trajectory could be misinterpreted as an unconditional commitment from the Board. Then, the CNB would risk its credibility as, sooner or later, its decisions would deviate from the trajectory. Even if professionals did not perceive the trajectory as a commitment, they could place too much weight on the information contained in it and rely less on their own analysis, which in the end could potentially impair the quality of their financial decisions and recommendations.

However, the risk of commitment illusion has been successfully reduced by extensive communication, and by stressing the uncertainties and assumptions of the forecasts. The uncertainty of key variables has been quantified using past forecasting errors and published in the form of fan charts.

How do you in retrospect evaluate the experience with publishing the IR path?

So far, I see the experience as very positive and in line with our expectations. After each board meeting, we closely monitor the reaction of forward interest rates to the decision and communication of the CNB. Since the CNB started publishing interest rates, the market reaction has been consistent with our intuition. In situations of no alternative presented and neutral balance of risks as seen by the board members, the forward rates tend to converge towards the forecast-consistent interest rates. However, if the outlook is surrounded by higher-than-usual uncertainty, as captured in an alternative scenario or risks identified by the Board, the forward interest rates tend to react much less.

In 2009, the CNB made another important transparency move: It started publishing model-based unconditional staff projection of the exchange rate to provide a complete set of information for forecast users, using fan charts underscoring the uncertainty. Again, what were the key drivers behind this transparency initiative, and what concerns the CNB harbored at the time, before going ahead with the publication?

When we started to disclose the interest rate trajectory in early 2008, the exchange rate trajectory became the only hidden part of the CNB’s forecast. There was a good reason for a more cautious approach to the exchange rate forecast, as compared to the interest rate forecast. Publishing the exchange rate forecast potentially creates much more room for financial speculation, which could, in the end, lead to a more volatile exchange rate. This concern was strengthened by the fact that the CNB forecasts the bilateral koruna-euro exchange rate, as opposed to some other central banks that forecast and publish the nominal effective exchange rate. However, favorable one-year experience with disclosing the interest rate forecast and the obvious benefit of reaching full transparency in the CNB forecast led the Board to the decision to start publishing a numerical forecast for the koruna-euro nominal exchange rate as from early 2009. With this step, the Czech National Bank became the first central bank in the world to unveil a forecast for a nominal exchange rate vis-à-vis a specific currency.

Did the experience with the FX rate path publication prove that some of the earlier concerns about increasing transparency were rather unfounded, and if so, in what way did things turn out more positive than originally thought?

Looking at the koruna exchange rate volatility, it did not increase in 2009, or in the following years. On the contrary, volatility declined from the elevated levels seen in late 2008 and at the beginning of 2009. However, this market development was mainly driven by the global financial crisis and the fact that we started publishing the exchange rate forecast had, in comparison to this global phenomena, only a marginal effect.

Considering it was a pioneer decision, I see it as a success that we did not face any major issues, and that markets correctly incorporated this additional information. I believe that knowing the CNB’s exchange rate forecast was very helpful for private professionals in their understanding of the CNB’s forecasts and their ability to check the forecasts’ internal consistency. We organize regular quarterly meetings with private professionals and they often ask questions regarding the exchange rate forecast. When the exchange rate trajectory is published, it is also much easier for us to answer these questions.

The CNB lowered key interest rates to “technical zero” in November 2012, and with the room for rate cuts exhausted, it used the exchange rate as a tool to ease monetary policy in November 2013, intervening on the FX market to drive the crown weaker. With that decision, it cut back on transparency and ceased the publication of the FX path, an exceptional move for one of the world’s most transparent central banks. What were the considerations that led to this unconventional transparency decision?

In 2014, the CNB ceased publication of the exchange rate forecast because with the introduction of the FX commitment the forecast trajectory did not contain any useful information. In fact, the exchange rate became an exogenous assumption of the forecast, and the koruna was expected to stay close to the exchange rate floor of 27 crowns per euro. Also, the uncertainty bands were no longer relevant, as the CNB’s interventions, either potential or actual, reduced exchange rate volatility to historically low levels. For all of this, I would not call the decision unconventional, it was rather a natural decision considering the altered role of the exchange rate in the CNB’s macroeconomic forecast.

The CNB has committed to resuming the publication of the FX path in early 2018 when it publishes the new macroeconomic forecast. This would be nearly a year after it returned to “normal” monetary policy and stopped the use of the exchange rate as the tool. What led the CNB to take this long to reopen the FX outlook embedded in its forecast?

As the end of the exchange rate commitment approached, it needed to be decided when the CNB would resume publishing the exchange rate forecast. In these discussions, the key argument for the later timing of this step was that the exchange rate trajectory could be interpreted by the markets as the desired trajectory and that the confidence levels (particularly on the appreciation side) could be perceived as thresholds that would trigger CNB interventions on the FX market. Therefore, it was decided not to publish the exchange rate forecast until the monetary policy returned to “normal”, i.e. interest rates returned to levels comfortably above the zero-lower bound and the koruna exchange rate found a stable footing at a new, market-determined level.

These conditions were met in the autumn of 2017. After two hikes in August and November, and with the outlook of further tightening this year, interest rates are now relatively safely above zero. Also, the exchange rate has developed quite smoothly since the exit from the exchange rate commitment. In light of this, the Board decided at its November meeting to resume publishing the exchange rate forecast as from February.

Do you expect to face any challenges when you resume publishing the FX path? How do you prepare for that?

Personally, I do not expect any problems to arise after we return to publishing the exchange rate outlook. Of course, we need to stress at every occasion that the exchange rate path should only be seen as a model-consistent trajectory, not as a desired path or even a CNB commitment. New information obtained after the preparation of the forecast, factors not covered by the forecast and risk assessment of the Board may, and most likely will, cause the actual exchange rate to deviate from the forecast. As before, we will illustrate this uncertainty by publishing the trajectory in the form of a fan chart. The confidence levels in the exchange rate fan chart will be, like in other variables, based on the errors of past – in this case, those preceding the exchange rate commitment – CNB forecasts.

The series of Q&As on the topics of transparency and communications previously featured Czech central bank Vice Governor Mojmir Hampl, National Bank of Georgia's Vice Governor Archil Mestvirishvili, and the then-new Bank of Ghana Governor, Abdul-Nashiru Issahaku.

Czech governor breaks central banking communications etiquette as he receives award

Czech National Bank Governor Jiri Rusnok blundered when receiving the Central Bank Governor of the Year Award for Central and Eastern Europe 2017 by Global Markets for “managing the removal of a three-year cap on the koruna with a minimum of market disruption”.

In his acceptance address posted on the Czech central bank’s website, Rusnok — a former politician just over a year in the top job — said with a subtle half-smile on his face:

“Along with the Swiss National Bank and the Bank of Israel, the Czech National Bank is the only central bank in modern history to have used the exchange rate so significantly as the main instrument of monetary policy. As is well known, the Swiss exit didn’t go too well. The Swiss National Bank is certainly not winning any awards for it, nor it is likely to.”

With those words, Rusnok seemed to mock his Swiss colleagues for failing to engineer a smooth exit from their exchange rate floor in January 2015.

The unspoken convention of central banking communications has long been that central bankers from one country do not tell their colleagues from another country what kind of policy should they pursue, nor do they criticise publicly their policy actions and pronouncements.

Rusnok’s words could be seen as breaking the etiquette. Absolutely unnecessary.

A communication gap between central bankers and the public

My former colleague, Czech central bank Vice-Governor Mojmir Hampl, in the OMFIF Bulletin on what he called a growing lack of understanding and a communication gap between central bankers and the public:

"... central banks have been warning about the risk of flooding for so long that they are now unable to explain that drought can be just as big a problem. They are also unable to explain that at times of drought you should water the garden, not keep draining it dry. And if the hosepipes are blocked, you must use other means to water the plants.

In tough economic times, it is difficult to describe quickly such a story to a public which is inattentive to the mysteries of complex systems. This is particularly true in the case of financially conservative and wealthy populations who strongly prefer future consumption to present consumption (and even more so in populations of net lenders rather than net borrowers like Germany, Austria or many other countries in central Europe).

This is the challenge which we, as a community of occasionally tedious central bankers, now face. We should hurry up."

Overcoming this challenge will be difficult, but hopefully not impossible...

Play a game... And chair the Fed

The Federal Reserve Bank of San Francisco has developed a "Chair the Fed" monetary policy game, allowing everyone to set the key policy rate instead of the Fed's mighty Open Market Committee.

Learn how monetary policy works by taking charge of a simulated economy.

The game is accompanied by a perfect set of FAQs providing explanations about the Fed's policy in simple terms.

While I was at the Czech National Bank, we produced a similar monetary policy game, called "The Captain of Inflation", as part of an educational campaign to mark the 20th anniversary of the Czech crown currency.

Banking like electricity: One cannot do without it

Czech Deputy Governor Mojmír Hampl, on what he called the trilemma of the banking sector:

What worries me is that over time many end-users (and also policy-makers) tend to look at standard commercial banks as utilities with all their typical features. One of those features is that the population is becoming more and more incrementally dependent on the services such utilities provide, quite often without the very same population even noticing it.

All this is happening on-line in small steps, incrementally, and all this means banks might in bad times be seen as utilities, much less resolvable due to the complex services they provide, than in the past. And the complexity of the services of a utility is sometimes visible only very shortly before its potential collapse. So “utilities” providing products with incrementally increasing dependence will be able to exit the market in a much more complicated way, if at all. The same applies to the financial sector, all the more so if we go down the road to a less-cash economy...

Winding down a highly-networked bank-utility in tough times is indeed going to be a real test of policymakers' resolve to resolve such an institution if and when such need arises.

BoE joins the 8-meetings-a-year club

Bank of England is cutting the number of regular policy meetings its MPC holds every year to eight. Until now, the MPC has met every month to set monetary policy.

In September 2015, the Bank announced that the Monetary Policy Committee (MPC) would move promptly to a schedule of eight regular meetings a year once the Bank of England Bill had received Royal Assent.

With the Bill having received Royal Assent on 4 May, making it an Act of Parliament, the Bank can now confirm the MPC will move to this new schedule.

Following its previously announced intentions, the scheduled MPC meeting ending on 13 October will be the first to be dropped under the new arrangements. Similarly, the meetings provisionally planned for January, April, July and October 2017 would also be removed from the schedule. The meeting schedule for the MPC will be updated as usual this autumn.

Scheduling eight policy meetings a year is becoming common practice among inflation targeting central banks.

Those who follow such 8-meetings-a-year routine include my former employer the Czech National Bank or Bank of Canada.

New Zealand's Reserve Bank is an exception, having switched as of this year to reviewing policy seven times a year instead of the previous eight times a year.

Wanted: New Chair of BIS's Financial Stability Institute

The Bank for International Settlements (BIS), also known as central banks' central bank, has opened the search for a new Chair of its Financial Stability Institute (FSI) to replace former Czech Republic's central bank governor and one-time prime minister of the country.

Up for grabs is a fixed, five-year term. A successful candidate needs to have at least 15 years’ experience in a senior executive position gained within a central bank, financial sector supervisory authority or international financial institution.

Purpose of the job:

  • To develop and define the overall strategy of the FSI, including optimising its assistance to authorities responsible for financial stability globally.
  • To assume overall responsibility for the FSI and to ensure the consistency, overall integrity and excellence of FSI services.
  • As a senior official of the Bank, contribute to the general management of the Bank.

The announcement suggests that current FSI Chair Josef Tosovsky, former Czech governor and a caretaker prime minister of the country in late 1990s, is retiring from the BIS's institute which he has chaired since December 2000.

Odd to see the BIS open the search for Tosovsky's replacement just as his name popped up in the news for his apparent reckless driving on a 2007 Ferrari.

A central bank challenge: Social media

Engaging in social media is certainly not an easy task for the world's central banks. Even more challenging it is for them to build, and crucially maintain, a successful presence in that online environment they neither own nor control. A central bank is a control freak by definition, and the lack of control has for years been a key reason for central banks' unease about social media.

Against this background, I was excited to have been invited as a speaker at last week’s Central Banking training seminar on "Communications and External Relations for Central Banks" in Windsor, United Kingdom. The seminar was all about central bank transparency and communication issues and the challenges central banks face nowadays in embarking on the strategy of openness and proactive communications with the public. My talk aimed to interact with the participants about ways of overcoming some of the challenges that central banks are facing in dealing with social media.

Below I quote an excerpt from my 2-hour long workshop with the participants from central banks in Europe, Asia, Africa, and both North and Latin Americas:

The key to understanding social media as an element of any central
bank's communication strategy is to consider the networks such as Twitter, Facebook or Instagram a communication tool, not a transparency tool.

Since transparency is a key precondition to successful communication, it is no surprise that very open central banks are predominantly exactly those which have begun routinely using social media as one of their communication tools.

If a central bank is not much transparent about policy, it has pretty much nothing to communicate, and as such it makes no sense for such a central bank to open a Twitter or Facebook account. In that regard, social media activity is merely a reflection of transparency.

Central bank websites have been transforming into digital news and information hubs, and the content they provide via those website hubs will over time naturally be reflected in whatever social and other media they operate at a given time. It is very clear that the words and images used to describe what central banks are doing will need to wary across media, and be tailored to the needs of each individual audience of a given medium.

As for transparency, I follow with interest the transparency-enhancing web activities of a growing number of central banks. Here I am specifically talking a live webcast of a press conference, of an analyst meeting, of a speech by the governor or another policymaker. These broadcasts, provided and paid for by the central bank itself, are non-discriminatory (available not only to subscribers of, say, Reuters or Bloomberg) and give the entire public an opportunity to follow policymakers' comments word by word. This is where in my view lies the next digital frontier of central bank transparency.