I was sitting around eating a date scone the other day when I ran into this article by Shamubeel Eaqub. The topic was central bank communication and whether the RBNZ (New Zealand’s central bank) was doing things well. Within a number of hours I’d been sent the link numerous times and had received a pile of feedback – with people on all sides fairly angry. This is an important issue though, so I thought I would note down my own thoughts while they are in my head.
As soon as the article was released I put down a cheeky facebook post among my own friends – I’ve now made it public to share here:
Now as it was among my friends I was assuming it would have context – but on a blog it doesn’t. So let me explain.
The economists at the RBNZ are excellent. They are intelligent, articulate, and passionate about economics. I’ve always found them insightful, and they have a genuine interest in balancing theory with realistic policy. In the same way, the heads of department and govenor have always been people interested in a balanced understanding of the economy and having an honest interpretation. Put this way, the individuals involved are doing an excellent job – I am sure Shaz feels the same way.
However, how are policy choices then communicated to the public? An independent central bank needs an ability to be credible – eg in the case of inflation targeting, when they tell people inflation is going to be some level price setters in the economy need to believe that when setting their own prices. Such credibility involves persuading the public the Bank knows what it is doing and clearly communicating what it is doing – as a third part the Bank also needs to be able to articulate why what they are doing is justifiable and within their mandate, or why some outcomes are the responsibility of government.
Now central banks – including the RBNZ – more than accept this as their role. And they actively do what they can to achieve this. In my comment I am stating that I think they rely too much on appeals to authority to persuade which leaves them vulnerable when their credibility does get undermined. Instead, communication has to be such that the Bank can be wrong (as all forecasts are wrong) and still maintain authority.
Note: To be clear the idea of “smartest person in the room” here isn’t meant to be an insult – it is just a way of saying “appeal to authority”. You put most people at the RBNZ in a room with me and they would be the smartest person in the room anyway 😉
Inflation targeting as a communication framework
Now a lot of people actually disagree with me on this point – and feel that appeals to authority are sufficient and necessary given the way people set expectations (some would say it is an assumption that people are stupid, but more realistically it is an assumption that people are time constrained when considering inflation). Of course, I disagree with those who disagree with me – as what we care about is the times when people reevaluate their price setting rules – if other institutions start to be seen as more persuasive than the Bank, due to the form of their arguments, inflation gets unanchored (and independence gets threatened). This gets MORE important when a financial stability mandate is also thrown in.
The RBNZs communication area is facing two difficult issues it has not faced before:
- The necessity of communicating about financial stability, due to changing regulation/policy in this space. Furthermore, the Bank now wants to set deposit holders expectations regarding losses so that risk is taken into account.
- A persistent period of low inflation due to repeated external shock has crept into inflation expectations.
To think about how the Bank should communicate about these ideas they need to clearly think “what are we talking about” whenever they are doing a specific statement. When Shaz mentions Carney it is because he has used the framework of inflation targeting to clearly communicate his views of monetary policy – one of the key advantages of inflation targeting is how it allows a framework that ensures households and firms can clearly set expectations regarding inflation and interest rates AND allows justifications for why inflation and interest rates differed from forecasts.
Inflation targeting, in this way, is a communication framework. It is credible and persuasive as the central bank can communicate how their choices can influence inflation, and how they will in turn act if outcomes vary from their expectations.
When it comes to then discussing financial stability and financial regulation, these issues are SEPARATE from the inflation target. Yes sure, financial regulation influences inflation and interest rates – that is lovely. But if your monetary policy framework is inflation targeting and you are a credible central bank you ARE setting inflation at your target level as a matter of credibility – financial regulation need not be a central part of your discussion of monetary policy, and if it does keep stealing the headlines at monetary policy discussions then it muddies the waters and makes it harder to communicate to price setters.
Without clearly splitting these issues for communication purposes you confuse price setters, which reduces the efficacy of policy.
And what is making this worse is the inconsistency in RBNZ discussion about financial stability. I recognise this is a work in progress, but changing the motivation for policies and pretending nothing has happened is poor – attacking policies (such as debt level targeting) and then turning around and introducing them as great ideas doesn’t actually indicate an open mind, but instead seat-of-your pants policy setting. This is fine for politicians but not a central bank where the rest of us have to have faith that you guys have considered the trade-offs involved deeply before making a statement on something 😉
Now I also disagree with Shaz’s “extroverted” examples. Rajan got himself involved in politics too much, which in turn confuses the role of the central bank govenor, and also has lost him his job. A good head isn’t trying to control policy, they are trying to cleanly meet their mandate as determined by a policy targets agreement. To me, the RBNZ has always clearly recognised their roll in letting the value of fiat currency depreciate at a known target rate (inflation) and they have done a good job with respect to it.
BUT, the communication around financial stability policy, the creeping confusion about the relative roles of monetary and fiscal policy in policy debates, and a frank lack of bloody minded language about doing everything they can to get inflation to target are all factors that have muddied the waters. The increasingly reactive nature of policy setting and speeches (rather than proactively pointing to targets in the future) combined with a growing muddle between monetary and financial policy is what led me to say I didn’t want to discuss this anymore.
In fact I don’t even want to discuss it now as this is NOT what I am currently thinking about. However, Shaz’s article motivated me to write something up – as I was a bit concerned people would focus on the potential attacks in his article, rather than just the suggestion that our Bank needs to remember its core competencies when communicating with the public. When put this way I am sure we are all saying something fairly obvious, something that many at the Bank would agree with but would merely have a different view on the trade-offs involved with communicating these ideas.
The RBNZ has great economists and good leadership, but should be using inflation targeting more forcefully (and without reference to financial stability) to meet monetary policy goals. At present, there is a risk that wandering into political issues, or the inconsistent explanations about what the Bank is doing, undermines monetary policy.
This is an issue around the world of course, and our Bank does do a good job – but it is worth reconsidering these issues from time to time to make sure the focus is on the core elements of what Bank policy should be doing, not the cute issues around the side.