Prior to the 1990s, central banks across the world were shrouded in mystery?and believed they should be. Conventional wisdom in central banking circles held that monetary policymakers should say as little as possible and say it as cryptically as possible, too. In 1981, Karl Brunner wrote in a seminal piece titled The Art of Central Banking with evident sarcasm: ?Central banking thrives on a pervasive impression that it is an esoteric art.
Access to this art and its proper execution is confined to the initiated elite. The esoteric nature of the art is moreover revealed by an inherent impossibility to articulate its insights in explicit and intelligible words and sentences.?
Fifteen years later, Alan Blinder, one of the leading researchers in the area of central bank communication and its economic effects, expressed a view of what central bank communications should be?one that had been lurking around in the underbrush but was far from mainstream at the time: ?Greater openness might actually improve the efficiency of monetary policy expectations about future central bank behaviour and provide the essential link between short rates and long rates. A more open central bank naturally conditions expectations by providing the markets with more information about its own view of the fundamental factors guiding monetary policy, thereby creating a virtuous circle. By making itself more predictable to the markets, the central bank makes market reactions to monetary policy more predictable to itself. And that makes it possible to do a better job of managing the economy.?
Five years later, the view that was expressed by Michael Woodford, one of the leading academics in this field, was: ?Successful monetary policy is not so much a matter of effective control of overnight interest rates as of affecting the evolution of market expectations. Therefore, transparency is valuable for the effective conduct of monetary policy. This view has become increasingly widespread among central bankers over the past decade.?
Notice the progression here: from Brunner?s 1981 lament about central bankers? refusal to communicate, to Blinder?s 1996 argument that more communication would enhance the effectiveness of monetary policy, to Woodford?s 2001 claims that the essence of monetary policy is the art of managing expectations ?and that this was already received wisdom?. The view that monetary policy is, at least in part, about managing expectations is by now standard fare, both in academia and in central banking circles. It is no exaggeration to call this a revolution in thinking over the space of a couple of decades.
These new ideas have made a mark on central bank practice as well. Though Greenspan has been discredited for his lowering of interest rates and fuelling a bubble that led to the financial crisis of 2008, he pioneered the practice of using central bank communication to explicitly manage expectations. For a person, who once prided himself on ?mumbling with great incoherence,? he instituted a substantial change by 2003 when he was explicitly managing expectations by telling everyone that the Fed would keep the federal funds rate low ?for a considerable period?. This guidance was only the latest step in what was, by then, a long march towards greater transparency that began in February 1994 when the Federal Open Market Committee (FOMC) first started announcing its decisions on the federal funds rate target.
In May 1999, the FOMC began publishing an assessment of its ?bias? with respect to future changes in monetary policy in its statements. It also began issuing fuller statements, even when it was not changing rates. About three years later, it began announcing FOMC votes?with names attached?immediately after each meeting. Starting in February 2005, the FOMC expedited the release of its minutes to make them available before the subsequent FOMC meeting. And most recently, starting in November 2007, the Fed has increased the frequency and expanded the content and horizon of its publicly released forecasts.
Other central banks have also become remarkably more transparent in the last 10-15 years and are placing much greater weight on their communications. In fact, the Fed is more of a laggard than a leader in this regard. The Reserve Bank of New Zealand and the Bank of England were early and enthusiastic converts to greater transparency, and Norges Bank (the Central Bank of Norway) and Sveriges Riksbank (the Central Bank of Sweden) may now be in the vanguard.
Arguably, the European Central Bank has been more transparent than the Fed ever since it opened its doors in 1998. More extensive central bank communication is truly a worldwide phenomenon.
One important driver of increased transparency is the notion that independent central banks should be more accountable?that they have a duty to explain both their actions and the thinking that underlies those actions. But the intellectual arguments just mentioned also played a role. As it became increasingly clear that managing expectations is a useful part of monetary policy, communication policy rose in stature from a nuisance to a key instrument in the central banker?s toolkit.
(To be concluded tomorrow)
The author is assistant professor of finance at Emory University, Atlanta, and a visiting scholar at ISB, Hyderabad
