Telling it straight

Last week I was fortunate enough to attend a speech given by MPC member Gertjan Vlieghe in which he argued quite forcefully that the BoE’s method of communicating with the market is flawed and that there are better ways to deliver a clear message on interest rates. This issue is particularly topical given the concerns expressed about the BoE’s recent attempt to convince markets there is still scope to raise interest rates, despite the apparent change in global monetary conditions which argues against such a move.

We should, of course, recognise that central banks have come a long way since they told us nothing about their intentions (I am indeed old enough to remember when the Fed first started publishing its interest rate announcements in 1994). Even if the BoE’s communications are imperfect, they are a considerable improvement on where we were just over two decades ago. In Vlieghe’s view, however, the BoE should move away from a process of  communicating the path of interest rates by showing “a forecast of what will happen if we do something else” to explicitly telling us its preferred path for rates. It is recognised by a number of policymakers that there is a problem with the current communications policy because it is impossible to derive a unique path for interest rates “simply by observing how far the inflation forecast is above or below target at the end of the forecast period.” In effect, the MPC is “asking outside observers to solve a complex reverse-engineering problem that cannot be uniquely solved.” 

A number of other central banks have adopted a policy of publishing a preferred path for interest rates in a bid to improve policy transparency with most of the evidence suggesting that they are more satisfied with this approach than with the partial transparency adopted by the BoE. I have argued previously that one of the arguments against this idea is that it could be interpreted as a commitment rather than a forecast – a criticism that Vlieghe accepts. But in his view, “none of the central banks that have made the change, have reported this type of systematic misinterpretation between forecasts and promises … They have taken active steps to ensure public understanding of the uncertain nature of the interest rate forecasts, often by publishing uncertainty bands or fan charts rather than only a central path, and always by emphasising the uncertain nature of the path and its data-dependence.”

But the BoE has gone to great lengths to do much the same thing – indeed it was a pioneer of using fan charts – and that has still not prevented large parts of the commentariat from criticising the BoE for the inaccuracy of its forecasts. My own concern is that in an environment where central banking is becoming increasingly politicised, it would be extremely unwise for the BoE to create a hostage to fortune by publishing a preferred interest rate path. Recall the criticism levied at BoE Governor Carney by MP Pat McFadden that he was like an “unreliable boyfriend” due to the hints of interest rate hikes that never materialised (“one day hot, one day cold, and the people on the other side of the message are left not really knowing where they stand”). Imagine how much worse that criticism would be if the BoE produced a path for interest rates that was not subsequently adopted.

I do increasingly wonder whether giving ever more information to markets under the guise of improving transparency might in any case be counterproductive. It always helps to have a little something extra up one’s sleeve in case of need, and an unanticipated burst of monetary tightening would certainly be a good way to fire a warning shot across the bows of the market. Not that central banks appear to believe they have a duty to take the punchbowl away these days, but there is a strong argument that they should be doing more at a time when expectations of further easing have helped to drive equity markets to record highs, even though there are few good fundamental reasons for this. Moreover, it is slightly ironic that central bankers should even be talking about publishing interest rate paths when rates have barely moved in the past decade. If anyone had published a path for European rates in 2009 that showed them at similar levels – or lower – 10 years on, they would have been laughed out of court.

Whilst I do take Vlieghe’s point, and I have a lot of time for his analysis, I do wonder whether he may be somewhat missing the point about communications. It seems that the more central banks communicate, the more markets want. Sometimes it might be better to give them a little fright every now and then.