Academic journal article The Reserve Bank of New Zealand Bulletin

Monetary Policy Communication and Uncertainty

Academic journal article The Reserve Bank of New Zealand Bulletin

Monetary Policy Communication and Uncertainty

Article excerpt

Central banks have become progressively more transparent in explaining to the public the rationale for a given monetary policy decision, often using economic projections as a vehicle for explaining policy issues. Nevertheless, increased transparency poses potential risks, particularly if the uncertainty around projected outcomes is not communicated in a way that avoids misleading readers. This article describes a number of the options available to central banks for communicating uncertainty.

1 Introduction

Over the past two to three decades, central banks have become more transparent about the motivation and thinking behind policy choices. Secrecy was once a hallowed concept, especially amongst central banks that managed fixed-but-adjustable exchange rates. However, the importance of central bank transparency is now more generally recognised. (1) In addition, the lags with which monetary policy actions affect the economy dictate that policy choices must be forward looking. As a consequence, projections of the future are always considered--whether explicitly or implicitly, formally or informally--as a part of the analysis of policy options. Publishing projections is therefore one way to increase the transparency of the policy-making process. (2)

However, publication of projections is not the only way to achieve effective monetary policy communication. Many highly effective central banks do not publish explicit, quantitative projections (eg the Reserve Bank of Australia). A problem of publishing explicit quantitative projections is that the world rarely turns out as projected. Measurement problems and delays in gathering statistics mean that even the current state of the economy cannot be known for sure; and no-one can know exactly how current influences on the economy will play out, or what future shocks might materialise. In a recent Bulletin article, we reviewed the Bank's forecasting performance, which emphasised the many uncertainties inherent in economic forecasting and the reality that most forecasts will inevitably be wrong to varying degrees. (3)

Publishing explicit, quantitative, point-precise projections therefore runs the general risk of creating unrealistic impressions of the central bank's ability both to accurately read the future and to influence it. Related risks include the following:

   If the interest rate projections are taken as a resolute
   commitment to a particular course of policy action, then
   those that interpret it as such will be misled. This issue
   is potentially more pertinent to the Reserve Bank of New
   Zealand because of our relatively unique approach of
   publishing a projected forward path for policy. (4)

   It may encourage an incorrect perception of a mechanical
   link between projections and policy decisions, when the
   reality of policy-making is far more complex.

   The central bank's competence, and hence credibility,
   could be called into question by the transparent
   revelation of forecast errors, potentially weakening our
   effectiveness in achieving the desired monetary policy
   outcomes.

It would be possible to diminish these risks by not publishing quantitative projections, or significantly disassociating published projections from policy decisions. However, there are other ways to mitigate the risks associated with publishing quantitative projections, while still maintaining the transparency and information value that publication of our projections achieves. This article discusses several of the devices that we use or have considered. These devices fall into three categories:

1 Striking the right balance between numbers (to provide quantitative clarity to the message) and words (to add a realistic degree of qualification and conditionality).

2 Describing alternative possibilities for the evolution of the economy.

3 Showing the extent of uncertainty inherent in the central projection. …

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