The more people understand monetary policy, the happier they are with central banks

Albeit fairly intuitive at first sight, now academic research has lent support to this notion: The more people understand monetary policy, the happier they are with central banks. Put differently, as a recent paper argues: “The less someone knows about central banking, the less likely he or she will be satisfied with the institution.”

Many central banks, from both developed and developing countries, have been running educational programs and reaching out to the wider public over the past years. Adriel Jost of University of St. Gallen and Swiss National Bank (SNB), provides clear justification for such efforts in the paper titled “Is Monetary Policy Too Complex for the Public? Evidence from the UK”:

Average satisfaction with BoE's policy since 2001.

Central banks have increased their engagement in the information and education of the broad public. But what can be said about the nonprofessional’s knowledge of monetary policy and central banking? Based on the Bank of England’s Inflation Attitudes Survey, I construct a score to capture the central banking knowledge of the respondents. I show that the average British person displays limited knowledge of central banking. At the same time, the data reveal that satisfaction with the Bank of England’s policies increases with a better understanding of monetary policy.

Investing energy and money to increase transparency and broaden communication outreach activities to financially educate the public and explain what central banks are doing and how seems vindicated by this analysis. That said, the paper also concludes, and quite rightly, that central banks might benefit from a certain level of financial ignorance among members of the public:

“No one can be forced to learn. People may simply have no incentives to learn about monetary policy, especially if they are generally satisfied with the central bank … All the more, ignorance in monetary policy may be appropriate, as monetary policy knowledge is less necessary in everyday decisions than financial knowledge.

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.

Never ending debate: Does central bank transparency do more harm than good?

A paper by two Swiss National Bank economists has cast doubt on the benefits of greater central bank transparency and increased communication in enhancing the predictability of monetary policy.

Thomas Lustenberger and Enzo Rossi, in their paper titled “Does Central Bank Transparency and Communication Affect Financial and Macroeconomic Forecasts?”, conclude that central bank openness and too frequent talk by policymakers tend to confuse private forecasters, causing errors in their interest rate forecasts.

The paper provides yet another contribution into the seemingly endless debate among academics and practitioners about the benefits and drawbacks of the shift towards greater transparency and more frequent communication in central banking over the past two decades.

As one would intuitively expect, and I completely agree with based on my experience in working with a number of central banks across the developing world, the paper suggests that there is no single, one-size-fits-all model for transparency and that its effects that vary greatly across countries and variables.

That said, the paper makes a number of important points that are worth considering by policymakers and communication managers in developing countries’ central banks aspiring to raise their policy transparency and enhance communication.

Don’t expect wonders from greater transparency:

  • central bank openness is not an effective instrument to improve the accuracy of private forecasts;
  • the publication of voting records is even detrimental to the quality of interest-rate forecasts;
  • more transparency contributes to aligning single forecasts with each other. From this perspective, transparency seems to provide the anchor by which agents’ forecasting actions are coordinated.

Don’t presume more talk is always better than less talk:

  • the verdict about the frequency of central bank communication is unambiguous. More communication produces forecast errors and increases their dispersion;
  • speaking less may be beneficial for central banks that want to raise predictability and homogeneity among financial and macroeconomic forecasts. We provide some evidence that this may be particularly true for central banks whose transparency level is already high;
  • a higher turnover of governors tends to reduce the precision of interest-rate and inflation forecasts. Greater central bank independence also tends to worsen the quality of forecasts, perhaps by increasing the size of monetary policy committees that may lead to cacophony.

Policy implications of greater transparency and enhanced communication

“… the policy implications are not clear-cut. If the policy objective is to get forecasters to provide more-precise forecasts, our results suggest that transparency is not an adequate tool to achieve it. However, if the objective is to align individual forecasts, then the general normative implication seems to be an increase in transparency.”

“… in order to improve the quality of forecasts of variables that are central to monetary policymaking and align them among professional forecasters, central banks ought to speak less often, especially those that have already achieved a certain degree of transparency.”

Caveat: Don’t read too much into the results of this study…

One important caveat is in order, a point made by the authors themselves: The study and its framework cannot be seen as definitely answering the question whether more or less communication is desirable and whether the degree of transparency should be increased or lowered.

“Our paper only studies the effect of communication and transparency on forecast accuracy and dispersion. Although the impact of communication and transparency on this dimension is important, there may be many other beneficial (or harmful) effects of giving public speeches or being transparent on, for instance, accountability, the public’s understanding of monetary policy, and trust in the central bank.”

Very true. One can never underestimate the benefits of well-designed communication in promoting the understanding of monetary policy, and with it developing public trust in the central bank.

Swiss central bank unusually transparent about FX action

Swiss National Bank gave rare confirmation that it had intervened in the currency market to weaken the Swiss franc in the wake of Britain's vote to leave the European Union, as reported by Reuters:

"Following the United Kingdom's vote to leave the European Union, the Swiss franc came under upward pressure," the SNB said in a statement. "The Swiss National Bank has intervened in the foreign exchange market to stabilise the situation and will remain active in that market."

According to Reuters, the SNB normally declines to comment on whether or not it has been active in the currency market.

This unusual transparency seemed to serve as a sort of statement on its own, to demonstrate to markets along with other major central banks that the SNB is alive and kicking and performing business as usual.

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.

Defence of independent monetary policy on euro area's border

Thomas Jordan, the Swiss National Bank's chief, in a speech on the challenges associated with pursuing independent monetary policy in euro area's neighbouring countries:

It is possible for a small open economy neighbouring a large currency area to conduct an independent monetary policy. Such a policy allows a central bank to address the specific needs of its own economy and to ensure price stability in the medium term.

The central banks of these ... countries neighbouring the euro area succeeded in regaining a certain room for manoeuvre by deploying unconventional monetary policy measures, namely negative interest, foreign exchange market interventions and quantitative easing programmes.

Jordan cited the experience of Switzerland, the Czech Republic and Sweden as supporting his conclusions. Worth reading for anyone interested in getting familiar with the issues faced by these small open economies with strong trade links to the euro area.