After ingesting the Trump agenda and spitting out its market implications, investors and traders can get back to their usual pastime: trying to work out what central bankers are plotting. Two vital meetings loom in the next 10 days.
The political upheaval in Italy means that the European Central Bank is all but certain to extend its big bond-buying program, due to end in March 2017, by a further six months when it meets on Thursday, December 8. Less than a week later, the U.S. Federal Reserve is expected to raise its main interest rate at its conclave on December 13 and 14 – a year after its first increase in almost a decade.
Federal Funds Rate Since 1954
As is now customary, posses of central bankers have been out in force on either side of the Atlantic, providing clues about their respective intentions. A speech in November by ECB president Mario Draghi set out “the reasons why we cannot yet drop our guard,” suggesting that he backs an extension of bond purchases. Meanwhile the Fed chair Janet Yellen said that an interest-rate increase “could well become appropriate relatively soon.” All this chit-chat may be good for the cottage industry of highly paid central-bank watchers, but monetary policymakers have become too talkative for their and the wider good, sowing confusion and losing credibility in the process.
This craze for communication is surprisingly recent. Central bankers once prided themselves for being taciturn and, if not that, inscrutable. Alan Greenspan, chairman of the Fed between 1987 and 2006, was famously gnomic. The first time that the Fed issued a statement immediately after a meeting of its rate-setters was in February 1994, when it helpfully pointed out that rates had gone up for the first time since early 1989. Not until May 1999 did the Fed start to issue one after each meeting regardless of whether there had been any changes.
Nowadays there is a surfeit rather than a lack of communication. Scarcely a day goes by without some pronouncement from a central banker whether in an interview, a speech, a press conference or in testimony to lawmakers. The case for more openness – to citizens and parliaments as well as markets – was at first straightforward. It formed part of a new model for monetary policy in which independent central banks sought price stability. In such a framework words count as much as deeds. They allow central bankers to mold expectations of future inflation, which feed back into actual inflation as businesses set prices and negotiate wages.
The need to communicate became even more pressing when the 2008 financial crisis caused economies to tank. Central bankers had to justify the unorthodox measures they took to restore growth and meet their inflation targets. In particular they needed to assure the public and parliaments that quantitative easing – creating money to buy bonds – would not kindle an inflationary fire. More recently the ECB has had to defend its policy of ultralow and indeed negative interest rates that vexes savers in the euro area and especially in Germany. Draghi, for example, stressed the wider economic gains from lower interest rates, including the relief for borrowers, when speaking to German lawmakers in Berlin in the fall.
Central banks have also intensified their attempts to shape expectations about monetary policy through “forward guidance.” Before the crisis central bankers sometimes dropped hints about impending rate changes in order to smooth their effects as traders anticipated the decisions. Jean-Claude Trichet, the ECB’s president between 2003 and 2011, would talk about “strong vigilance” when the bank was contemplating a rate rise.
But forward guidance goes beyond hints about short-term decisions to explicit undertakings about the longer-term stance of monetary policy, including dates and thresholds for a critical gauge of the economy such as unemployment.
Central bankers have overdone their attempts to talk their way out of an economic hole. Attempts to direct markets well into the future have lost credibility as policymakers failed to follow their own signals. Mark Carney made forward guidance his signature tune when he took over as governor at the Bank of England in the summer of 2013, but it soon went off-key. The Bank swiftly had to abandon a guideline linked to falling unemployment as the jobless rate sank much more rapidly than expected.
If forward guidance has proved too ambitious, communication can also come unstuck through infighting within the crucial committees that determine monetary policy. What central bankers have to say in public may then reflect internal divisions rather than offering a window into an agreed direction for policy. Typically, heads of central banks will get their way, but not always. A year ago, for example, Draghi disappointed the markets when the ECB delivered less than he had appeared to offer in the run-up to the December meeting. The central-bank gazers had put too much weight on his views and not enough on those of other, more cautious, members of the ECB’s 25-strong governing council.
Overtalkative and at times quarrelling central bankers undo the potential gains from communication. The signal gets lost in the noise. As worrying, the febrile focus on what monetary policymakers have to say reveals how dependent markets have become on central banks. This is a clinch that has become too tight for both sides.
Breaking the clinch through restoring more normal monetary-policy settings will have to be undertaken delicately and gradually. But in the meantime a little less talk from central bankers would be no bad thing. Central bankers are no doubt flattered by all the attention they receive. But they are not rock stars – and they shouldn’t expect to get that kind of attention.
Paul Wallace is a London-based writer. A former European economics editor of The Economist, he is author of The Euro Experiment, recently published by Cambridge University Press.