Transparency and communication in monetary policy
Introductory remarks by Mr Malcolm D Knight, General Manager of the BIS, at the Joint BSP-BIS High-Level Conference on Transparency and Communication in Monetary Policy, Manila, 1 February 2008.
Central banks have come a long way in addressing the issues of transparency and communication in monetary policy. Today they take the desirability of transparency almost for granted. They now state their goals, announce and explain their policy decisions, and describe the outlook as they see it. Once they have decided what to be transparent about, they come to the tricky part - the communication strategy. The content, the modalities and the timing of the release of information, all these are important.
It is a great pleasure for me to be part of this conference, and I join Governor Tetangco in welcoming you all. Given the events of recent months, I think everyone will agree that our topic today, transparency and communication, is central to the effective implementation of monetary policy. Indeed, as soon as I heard that this was the topic being proposed, I was especially happy that the Bangko Sentral ng Pilipinas wanted the BIS to be associated with the conference.
To put this conference into context, let me recall a bit of history. In 1987, William Greider published a book called Secrets of the Temple. It was about the US Federal Reserve, but Greider could have been describing almost any central bank at the time. Here is what he said about the Federal Reserve of the mid-1980s:
"Its decisions and internal disputes and the large consequences that flowed from them remained remote and indistinct, submerged beneath the visible politics of the nation. The details of its actions were presumed to be too esoteric for ordinary citizens to understand."1
Just the year before, Alex Cukierman and Allan Meltzer had published in Econometrica their seminal paper, "A theory of ambiguity, credibility and inflation under discretion and asymmetric information". This was the first paper to seriously consider the issue of transparency in monetary policy, and in it Cukierman and Meltzer actually concluded that the case for transparency was ambiguous.
The papers that will be presented today and the discussions that will engage us will show that we have indeed come a long way since Greider's book and Cukierman's and Meltzer's paper. Central banks today take the desirability of transparency almost for granted. They now state their goals, announce and explain their policy decisions, and describe the outlook as they see it. Some have even taken steps to reveal conditional forecasts of their operating targets.
We know about the forces that have brought about this sea change in attitudes and behaviour. Let me mention briefly four of these forces. First, as more central banks gained policy independence, they saw the need for greater accountability. Second, central banks have come to the view that, for their monetary policy framework to work effectively, transparency about their policy objectives is a critical element. This is, perhaps, particularly the case for those central banks that have adopted an explicit inflation targeting framework, but I believe it is so more broadly for all central banks. Third, as financial markets have become more important in the transmission mechanism, central banks have increasingly recognised that their policy actions are more effective when market participants understand both the actions themselves and the objectives underlying them.
And there is a fourth important consideration that has tended to be neglected in academic discussions, and that we at the BIS consider , very important for the proper functioning of the global financial system. This is the desire to foster a level playing field in financial markets. Let me use the US Federal Reserve as an example. At the time Greider wrote his book, the Federal Open Market Committee (FOMC) did not announce its policy decisions. Instead, market participants learned about monetary policy from the operations of the New York Fed's domestic desk. Every day after 11.30 am, the New York Fed would notify primary dealers about the amount of repo transactions it would like to carry out that day and whether the transactions would be for foreign official customers or the Federal Reserve System. The code words were "customer" and "system", with the latter having significant implications for monetary policy. From this privileged information, primary dealers would infer the monetary stance. This, of course, gave these 30 or so primary dealers in New York a tremendous advantage, because they could then take the appropriate investment positions before anyone else. All this has changed with the advent of transparency. What is key today is the public release of the FOMC announcement, which everyone in the world receives at the same time.
Recent events in global financial markets might suggest that the progress made on transparency in monetary policy should be replicated in the area of financial instability as well. Here two specific questions come to mind: Should a central bank that perceives an asset market bubble disclose its assessment even when it has little direct control over such asset prices? Or, when asset prices are on the way down, should a central bank share its assessment of the likely adjustment in asset values?
Once we have decided what to be transparent about, we come to the tricky part - the communication strategy. The content, the modalities and the timing of the release of information, all of these are important. When I became Senior Deputy Governor of the Bank of Canada in 1999, the Bank did not have preannounced policy action dates, and we used to make policy decisions and announce them on whatever date seemed warranted by domestic economic conditions. However, the markets tended to think that we were merely "following the Fed". To disabuse the markets of this misinterpretation, we decided to announce the setting of our policy interest rate on regularly scheduled and preannounced dates. This seemingly minor change in our communication with the markets and the public turned out to be of key importance to the functioning of Canadian monetary policy, particularly in stimulating a much more informed discussion of monetary policy actions in our media, in the markets, and even among the general public. Let me now get our discussions rolling by giving you a preview of the papers that will be presented today. In doing so, I will try not to give away too many of the punchlines.
Professor Sylvester Eijffinger will recall the key questions that the academic literature has tried to answer in this area. The answers to the questions lend increasing support to the idea that more transparency is often better than less. Hence, transparency about goals, transparency about policy decisions, and transparency about the central bank's performance - all these are seen as good forms of transparency.
Diwa Guinigundo and Andy Filardo will present a paper that analyses and interprets the results of a special survey of central banks' communication practices. The survey was conducted by staff at the BIS Asian Office on behalf of the central banks of the Asian Consultative Council of the BIS Board. Diwa and Andy find that, broadly speaking, all the central banks represented here have bought into the idea of transparency, and this has translated into better macroeconomic performance.
Next, Alicia Garcia-Herrero and Eli Remolona will look at interesting aspects of the way central banks communicate with the markets. For example, they will ask why many central banks have chosen most of the time to move their policy rate targets by only small steps, often of 25 basis points at a time, increments characterised by Willem Buiter as "chicken feed".
Professor Hyun Shin will offer a new perspective on how central banks manage expectations. He will raise fundamental questions about the primacy of the expectations channel of monetary policy. And he will also draw implications for communication strategies for central banks that operate in an environment where the links between policy interest rates and longer-term rates are tenuous.
I look forward not only to these papers but also to the discussions we will have. I am especially eager to hear from the central bank representatives about which communication strategies have been successful, what frustrations they have faced lately, and what options look most promising for the future.
1 W Greider, Secrets of the Temple: How the Federal Reserve Runs the Country, Simon & Schuster, 1989, pp 11-12.