Fixing the Bank's communications
The Bank of England has a communications problem. That matters at a time of volatile data. Fixing it requires both operational improvements and a more proactive approach.
The Bank of England has a communications problem. Luckily for the Monetary Policy Committee, there is helpful advice to hand. I don’t, of course, mean the recently published Bank staff working paper entitled “Mark my words: the transmission of central bank communication to the general public via the print media”. Which, while a wonderful example of economics for economics sake, is not exactly a useful primer on communications.
For example:
We consider a representative newspaper that is a profit maximiser. Furthermore, since we are only considering news related to monetary policy, we can think of the newspaper’s problem as more accurately being the journalist’s problem. The journalist tasked with economic reporting has one choice variable: k. k represents the fraction of an article that directly paraphrases the central bank. The journalist faces a trade-off. Writing news that satisfies consumer desires will sell more papers, but requires effort. Paraphrasing the central bank may not align with consumer desires, but is costless. An article produced by the newspaper is constructed as follows. Proportion k of the article is paraphrased central bank communication, and has characteristics equal to that of the central bank’s communication (θB). Proportion 1−k of the article is created by the newspaper. Since the newspaper is profit maximising, proportion 1 −k of the article will be exactly aligned with consumer desires (θ ∗ ).
Now, having gotten k out of the way by directly quoting the central bank I can return to satisfying the consumer desires of my readers with the rest of this piece (or the 1-k proportion if you prefer).
A better place to start would be with another Bank working paper published on the same day. This one has less, erm, practical advice on central bank communications but reiterates it’s importance.
The paper looks at the optimal policy mix when rates are stuck at the lower bound (the zero lower bound or ZLB in the paper) and the economy suffers a negative demand. It notes that central banks have, even when rates cannot be practically cut further, tools in the form of either expanding their balance sheet (via QE type polices) or through communications to shape expectations (forward guidance or, to the clearly acronym-loving Bank researchers, FG).
It concludes that the optimal policy mix would use a mix of both.
…following a negative demand shock at the ZLB, the optimal monetary policy under commitment implies a mix of FG and mild adjustments in the balance sheet size. Specifically, FG boosts expectations about inflation and the output gap, an initial increase in the size of the balance sheet further eases the initial drop in demand, and a subsequent contraction mitigates the overshoots in prices and real activity. The presence of balance-sheet policies reduces the optimal duration of the ZLB required to stabilise inflation and the output gap. Under discretion (defined in the paper as when the central bank cannot commit itself to future policies), instead, the central bank is unable to carry out FG and can only rely on balance-sheet policies to stabilise inflation and the output gap. Compared to the optimal policy under commitment, the absence of FG leads to lower inflation and output-gap stabilisation and a stronger increase in the central bank’s balance sheet.
A core argument of the paper is that, in circumstances like the present, clear communications about future policy is not a “nice to have” but a core part of the central bank’s toolkit. None of this should be especially controversial. Which is why I found myself raising an eyebrow at Andrew Bailey’s insistence last week that managing market expectations about future policy was not his job. Sure, it is not the Governor’s job to let the market know if rates will be rising in December vs in February but it is surely the MPC’s job as a whole to prevent the kind of unwarranted monetary tightening seen in October?
In today’s FT, Moyeen Islam of Barclays (one of the best BOE watchers) has a superb comment piece on the need for better BOE communications. As he notes, this is especially important in a time when the macro data is volatile.
Still, while I am fully onboard with his view that the Bank needs to up its game, I am less sure that the best way forward would be adopt Gertjan Vlieghe’s suggestion of two years ago and for the MPC to be more open about its own interest rates forecasts.
The BOE could, if it so wished, follow the Fed and publish its own version of the dot plot, with each of the 9 MPC members noting where they thought bank rate would be in the future.
If we want people to understand what we, the MPC, think is the necessary path of interest rates to achieve the inflation target, why not just tell them?
But I’m not sure that would have helped with last week’s debacle, or at least not in major way. With inflation running ahead of the Bank’s August forecast, Bailey’s suddenly hawkish tone could easily have been interpreted as him revising up his own rate projections or as shift in the wider MPC’s thinking and with Pill as a new member of the committee he would always have been seen as an unknown element.
More generally, I have a lot of sympathy with Claudia Sahm’s view that the dot plot has outlived its usefulness in the US.
I think the best that be said it that when central banks were trying to find a way to give low rates more bite by emphasising that they would be lower for longer than the market expected, then the dot plot had a purpose. In an era when central banks are trying to signal that policy support will indeed be withdrawn but at a slow and measured pace, I am not sure how much help they would actually provide.
I fear the market would concentrate too much on exactly when “lift off” would happen and not enough on the really important information: the fact that the peak would be historically low.
Short of publishing rate forecasts though, there is plenty the Bank could do to improve its communications. At a basic operational level, it could follow in the footsteps of the ECB and publish interviews and comment pieces in an easy to find section of its website. I have no problem with MPC members giving interviews or writing articles for paywalled publications such as the FT or the Telegraph1, but I do have a problem with them staying behind paywalls.
If the Governor is going to make remarks to the G-30 that change market expectations about policy, the Bank should be publishing a transcript as soon as possible.
Beyond that though and recognising that expectations about policy sometimes matter as much as policy itself, the Bank should be more proactive in pushing back when the markets swing too wildly in either direction. If the Governor’s remarks are, to be charitable, being misinterpreted then another MPC member should be wheeled out quickly to make another intervention. Mistakes can be forgiven. Not correcting them quickly is the real problem.
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