Central Bank talking…from too much to too little?

Economists continue to remain silent about the many theories/ideas they had created in the 1990s and won a lot of admiration/tenures in the process. Most of these ideas are being questioned now but the hype over what econs can do continues. One such idea was importance of central bank talking which was euphemistically called central bank communications. The  notion was that central banks should communicated as much as possible to markets, communications are a potent tool as open mouth operations as important as open market ones and so on. Be more and more transparent. These talks were to guide market expectations, anchor inflation expectations and what not. From a non-entity, central bankers became a highly followed figure with each word being tracked and analysed.

Cometh the crisis and things like forward guidance were seen as a highly important tool. Central bank after central bank came with new ways to guide markets. Some indicated a date, some indicated amounts and some both.  We are all seeing these ideas failing badly now. Central banks have become victims of their own perceived success. All these things like communications and transparency have just made markets highly reliant on central banks. This has created huge uncertainty as we have seen in the last 4-5 years.

Satyajit Das has a piece on the same:

During the Second World War, everyone understood that loose lips sink ship. Over the last 18 months or so, central bankers and policy-makers have disregarded this advice, becoming excessively chatty. Research confirms the increase in length and complexity in the US Federal Reserve’s statements, paralleling the rise in the size of its balance sheet.

Facing intractable problems and difficult choices, politicians have abnegated economic leadership to central bankers. With limited policy options available, central bankers have resorted to “forward guidance”; a tautology as any guidance must be about future events. They now communicate commitments on future interest rates, liquidity provision or QE and currency values over a medium- to long time horizon.

Forward guidance suffers from a number of weaknesses. Focus on any single or a narrowly based set of indicators, such as unemployment or inflation, is not meaningful. Forward guidance relies on the accuracy of central bank. Guidance is highly conditional. Central bankers have ‘no skin in the game’ with central bankers’ tenure or remuneration is also not linked to outcomes.

An unanticipated trigger event can lead to a sudden and sharp automatic rule-based central banking response or policy change. In January 2015, the Swiss National Bank’s sudden decision to abandon its currency peg highlights the problem. It created volatility and uncertainty, precisely the opposite of the policy intention. Forward guidance increasingly confirms John Maynard Keynes’s fear that: “confusion of thought and feeling leads to confusion of speech”.

But econs have not learnt:

Theorists and central bankers are animated about forward guidance, with a torrent of papers and conferences on the subject. But increasing reliance on forward guidance is drawing unwanted focus on the limitation of central banking instruments and policy. With fiscal policy constrained and monetary policy stretched, the real problem is few available options, with central banks forced to experiment with techniques of unknown efficacy and potentially toxic side effects, including direct intervention in markets and pricing mechanisms.

As the Swiss franc episode reinforces, central bankers are not divine beings with supernatural powers. They are subject to market forces.

The current artificial economic environment is based on central bank manipulation of markets and prices and suppression of volatility. Despite the chatter and ‘spin’, it will not end well!

We could see central banks going back to the mysterious and tight lipped  ways of the past. The SNB move was one such example where the central bank chose to shock the market rather than guide the same.

All these factors keep reinforcing the old ideas of looking and fixing real factors with lesser attention on the financial ones. This will require much lesser attention on the central banks which have become way too central to our lives.

One Response to “Central Bank talking…from too much to too little?”

  1. Samuel Says:

    Central banks are not as transparent as they seem to be, the economics literature is already showing it: http://onlinelibrary.wiley.com/doi/10.1111/coep.12049/abstract

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