Dialogue Chain. Episode 10.
Stephen Cecchetti, Professor of International Economics, Brandeis International Business School, and Ksenia Yudaeva, First Deputy Governor, Bank of Russia
Yudaeva: Steve, welcome! We had a conversation two years ago if you remember and we discussed inflation targeting. And today, I would like to discuss with you in a little bit more detail communication policy. And let me start with a very general question. Why do central banks need to communicate? Who central banks need to communicate to? And very generally. How should they communicate?
Cecchetti: This is a very good question. The answer could be very long. Let me try and be a little bit brief. So, the first thing is that central banks are delegated power by the public and their elected officials. And so, they are accountable to those… to the people. And so, one of the reasons or maybe the very first reason to communicate is to explain what you are doing so that you remain accountable to those people. Now, of course, you have to communicate also with elected officials and you need to communicate with technical specialists in the financial markets but those things I think are secondary in some sense to communicating with the average people. So, the first step is that you need to speak very plainly and you need to speak in plain language and this is a complex and difficult thing to do. But something that I think all central banks, especially inflation targeting central banks, need to work on. Then, what is it that you are supposed to communicate? Well, the first thing you need to help people to understand what it is you’re doing and why you’re doing it. And then, help them to understand how it is that you are likely to react as the conditions change. Now, this is sort of… sounds a little bit odd at first. And it’s not about giving people some sort of prediction of what it is that you’re actually going to do because you don’t know what you are going to do. But it’s about making sure that you don’t become a source of volatility. The fastest way, I think, to lose people’s trust and credibility is to claim you know things or get trapped into saying things you don’t really know. One of the reasons that central banks are made independent is because they have longer horizons than politicians. We know that independent central banks are more likely to provide stable prices and foundations for high stable growth. So, the economy is more stable with a central bank that is independent. But it’s important then again that you constantly remind people that that’s why you’re doing this and that all of your actions are linked to that.
Yudaeva: Okay. So, it is a part of accountability and transparency. But let me introduce one more dimension. Is it actually a policy tool? So, can you actually affect expectations, try to manage expectations in news communication as a policy tool? Or it is rather just this transparency exercise?
Cecchetti: I think that’s something people have discussed quite a lot in recent years. And I think that the answer to the question depends on the conditions, which is maybe not a great way to start. But my view is that you start with traditional, conventional monetary policy and conventional tools and in that case again it’s helping people to understand how you’re going to react to conditions. And the communication itself is not a tool. But if you are in a position where conventional tools are insufficient to provide the policy easing or the impetus to growth in the economy, so the economy is such as it has been for many years in advanced economies, then promises about future policy become a tool as well. But I would say that for emerging market countries, for countries that don’t have nominal interest rates, policy rates that approach the effective lower bound, whether it’s zero or slightly below zero, that I would not advocate using expectations and communication as a tool in and of itself.
Yudaeva: Interesting. Because one of the issues, which usually pops up in this kind of discussions, is an issue whether central banks should publish their interest rate forecasts in one form or another…
Yudaeva: Or not.
Yudaeva: So, what is your position on that?
Cecchetti: I would back up a little bit and I’d say what’s more important is to be clear about your forecasts for economic conditions. So that again people can understand that if those conditions change if conditions turn out to be different from what you expected, that your policy is likely to change as well. So, it’s this connection between interest rates and economic conditions that’s important. It’s how you’ll react. But publishing the forecasts of interest rates themselves, I think, is not something that I believe has… is that advisable? If you look at the countries that have done that with some regularity – mostly Nordic countries and they tend to be small. New Zealand has done that, Norway has done it for a long time. And Sweden does it. I think that in these places you can get yourself into trouble, it creates communication problems.
Yudaeva: So, how much freedom central banks should have? How many surprises they may produce? Or the market should be completely prepared to all of the decisions of the central bank to not increase the volatility of the market?
Cecchetti: First of all, I think that central banks should work very hard to retain flexibility. I think it’s a big mistake to lock yourself in. I mean, we’ve seen this in a number of cases. I mean, over the last few decades we can easily find examples of central banks that decided that they were going to increase or decrease interest rates by small increments at every policy meeting and everyone expected it. And that’s a trap in my view. I don’t think it’s advisable. But I do believe again that you need to be clear about how you will react to changes in conditions. So, the trap is that you put yourself into a position where you’ve assured people that over the next, you know, 3 months or 6 months or 12 months you gonna do something. But then conditions change, and so you change your commitment such as it was. But that’s something you should be allowed to do. So, if we look right now at what happened, for instance, in the last few months, at various points uncertainty associated with global conditions has changed. This is something that if you have a policy commitment then you wouldn’t be able to change your path.
Yudaeva: What kind of communication tools for the monetary policy do you think are the best? Shall central banks publish minutes of the meetings, shall we publish press-releases, conferences? Who should speak on behalf of the central bank, right? It’s a very multidimensional space.
Yudaeva: What do you think is the best practice?
Cecchetti: So, I’m not sure there’s a best practice, because obviously, the structure of decision making in central banks differs quite a bit as you go across countries. What I would say is that the first thing is that I think statements of the policy decisions that come quickly afterward and are worded in ways that are very accessible to as a broader audience as possible, I think those are very important. I mean, in addition, central banks produce a huge amount of other technical material that’s important and valuable again for analysts and technicians, for people, who are very sophisticated, to try and help them understand how it is that modeling is done and what are the inputs into this decision. But to go back to where I started, for communication with the general public, I think that stuff is… that’s not the focus of what central banks should be doing.
Yudaeva: Okay. So, as far as monetary policy is concerned, although there’re different instruments, but still there’s maybe, some way we could define the general standard, right? Let’s start with macroprudential. So, how do you think they should go? Shall we follow the monetary policy example or should they have more room for surprises, let’s put it this way?
Cecchetti: Well, again there, I think, it depends a little bit on the tools that you have. In general, I would say that you have to work to not surprise people. Announcements should be things that people sort of understand are likely to come as a consequence of changes in conditions. So, your announcements are resolutions of uncertainty in the minds of the public and firms in the markets, they should be very big resolutions of uncertainty, it should be small surprises. Now, the one case that I think is more difficult is the exchange rate intervention.
Yudaeva: Right. That’s what I was gonna say.
Cecchetti: Right. So, the exchange rate intervention is much harder because of course in most of exchange rate interventions you sort of have to surprise people. Now, I think that we need to be more creative, we need to think harder about exchange rate intervention and whether there’re mechanisms to manage exchange rates that don’t involve surprises.
Yudaeva: Okay. Can we think about it in this kind of way: when we speak about financial stability there’re preemptive tools, most of them are preemptive, you try to preempt accumulation of vulnerabilities. And you have sort of fast reactions to risks, which have realized. Can we put it in this way that the first ones should be a bit more predictable than the second ones?
Cecchetti: I think that’s a very good distinction. It’s surely the case that preventative tools are things that people need to understand exactly how you are going to put them in place and when and why. Once something happens and you have to manage a risk that has been realized, you know, something that’s actually… Crisis management is very different from crisis prevention. In crisis management you do what you need to do, you have to do it quickly, and then you explain afterward.
Yudaeva: And do people need to know how you react to crises? It’s a question of moral hazard, right?
Cecchetti: Right, right.
Yudaeva: And do you create moral hazard by transparency or you don’t create?
Cecchetti: I think that there we have to think harder about what that means, but I think, in the case of… I mean the central bank has been a crisis manager as a lender of last resort sort since the beginning, and I think it does create moral hazard with the lender of last resort, but I think that we agree that we need the lender of last resort. So, to the extent the things are like that, that they’re automatic responses, then we live with the consequences and we put in other policies to try and mitigate the moral hazard that we’ve created.
Yudaeva: Okay. This has been a very interesting discussion. I hope we can continue it some time later. My last question to you. You know, it’s a chain interview. So, who would you like to interview next?
Cecchetti: Oh, that’s great. I think… the person I think it would be very interesting to talk to Gabriel Di Bella who is finishing his time as the IMF’s resident representative in Russia and has thought quite a lot about fiscal policy rules.
Yudaeva: Oh, yeah. That is actually a question, which is very closely connected to the last issue, which we discussed in our conversation. So, thank you very much, Steve. This was fantastic. Thank you.
Cecchetti: Yeah, thank you.