Academic journal article Journal of Economic Issues

Effective Central Bank Communication under Uncertainty

Academic journal article Journal of Economic Issues

Effective Central Bank Communication under Uncertainty

Article excerpt

In the last 20 years or so, central banks around the world have become increasingly more transparent. This trend has coincided with the move toward greater central bank independence. This coincidence is no accident, as transparency is often thought to be necessary to satisfy the principle of democratic accountability by independent central banks. Some comprehensive surveys of this recent movement can be found in Blinder et al. (2001) and Blinder (2004).

Political considerations are an important justification for transparency. The old mystique of central bank secrecy is no longer the byword in today's policymaking circles. As Joseph Stiglitz put it, "[n]o-one would dare say that they were against transparency ... : It would be like saying you were against motherhood or apple pie" (Financial Times October 5, 1998). Briault, Haldane, and King (1997) and Stiglitz (2001) emphasize the importance of transparency in a democracy. In their opinion, central banks should provide more detailed explanations of their views on monetary policy in order to enable the public to evaluate their performance (see also Buiter 1999; and Geraats 2002; 2006).

There are also compelling economic arguments for transparency. For one, transparency increases policy effectiveness by enhancing the public's understanding of the monetary policymaking process. The reasoning behind the argument goes as follows. In modern policymaking, central banks rarely use credit controls or directly manipulate long-term interest rates to regulate the flow of funds in financial markets and institutions--they usually do not have enough information to implement these policy options effectively (see Sellon (2003) for an enlightening discussion). Instead, they typically seek only to directly influence the overnight interest rates in some interbank markets for central-bank balances. Yet, relative to the enormous size of global financial markets, these markets for overnight borrowing and lending by commercial banks are usually too small to affect aggregate economic activities significantly by themselves.

The manipulations of short-term interest rates can significantly affect the public's decisions on spending, pricing, and employment only if the current and expected future changes in these short rates can be used as a lever to influence the longer-term rates, asset prices, and exchange rates, etc. This lever typically works through market expectations on the term structure of interest rates. This link from the current short rates and, more important, the expected future path of the short rates, to the long rates "is not like steering an oil tanker, or guiding a spacecraft ... that does not depend on the vehicle's own expectations about where it is heading" (Woodford 2004). The fact that it is the market expectations of the future settings of the short rates that can significantly affect the public's economic decisions provides a convincing economic justification for transparency. If transparency can help financial markets develop more accurate expectations of the likely future course of the funds rate, policy will be more effective, and risks in financial markets should be reduced as well (Bernanke 2004). (1)

On a more general level, economic problems can often be viewed as coordination failures in the broader social-institutional context. This notion has been emphasized by not only the original institutionalists and the post-Keynesians in the tradition of Thorstein Veblen, John Commons, and Clarence Ayres, but mainstream economists as well (see Cooper and John 1988; and Ball and Romer 1991). In solving the coordination problem, monetary policy intervention should promote the learning process of the private agents and mediate the interaction between people (see Eisner 2001; Wennerlind 2001; and Miller 2002; among others). Transparency is an important ingredient of this solution.

Thus, a strong case can be made that central bank transparency is justified on the grounds of democratic accountability, policy effectiveness, and institutional efficiency. …

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