(Bloomberg Markets) — Central bankers once seen as the world’s economic crisis fighters are now desperately trying to contain a problem they let happen: inflation. This eroded its credibility in the eyes of investors and society at large.
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Officials offered mea culpas. US Federal Reserve Chairman Jerome Powell acknowledged in June that “with the benefit of hindsight, we’ve clearly done” underestimate inflation. Her counterpart at the European Central Bank, Christine Lagarde, made similar concessions, and RBA Governor Philip Lowe said in May that his team’s forecasts were “embarrassing.” In October, South African Reserve Bank Governor Lysitja Kganyago warned at a monetary policy forum that central bankers take a long time to build credibility — but it can suddenly be lost.
It is hard to justify the independence of central banks after such a failure to “analyse, forecast, act and communicate,” Allianz SE chief economic advisor Mohamed El-Erian said last October. The tragic outcome, he says, is “the most loaded interest rate cycle we’ve seen in a very long time, and it didn’t need to be.”
The first step for the newly humbled monetary policymakers is to put prices back under control without wreaking havoc on the economy. Then they must change the way central banks operate. For some experts, that means three things: shrinking their mission, simplifying their messaging, and staying flexible.
“Do more by trying to do less,” is how former Reserve Bank of India Governor Raghuram Rajan describes his advice to central bankers.
Back to basics
The Fed’s big miss on inflation led Powell to invoke the lessons of Paul Volcker, who he famously tamed in the 1980s.
Since Volcker’s resignation in 1987, the Fed’s powers have expanded. Alan Greenspan, who held the presidency until 2006, rode a productivity boom to reduce inflation, but also stepped in to prop up markets whenever there were threats to the economy. When reckless lending finally exploded the housing and credit markets in 2008, then-chairman Ben Bernanke spread out the Federal Reserve’s balance sheet in ways not seen since the Great Depression.
After emerging from the Covid-induced recession, it looked as if central bankers had pulled it back in, led by Powell. Their coordinated response in March 2020 set a floor on asset prices and kept bond yields low, helping governments fund the massive spending needed to support the millions of unemployed people. With inflation still subdued, central bankers have taken charge of tackling problems like climate change and inequality – including setting a new “broad and inclusive” employment target. Meanwhile, stocks, bonds, and cryptocurrencies were racing higher. Then came consumer prices as well, which central bankers didn’t expect.
The Fed’s new policy framework prevented a more aggressive approach to inflation, says Carl Walsh, an economist at the University of California, Santa Cruz, who previously worked at the Federal Reserve Bank of San Francisco. He cites the words of the Federal Open Market Committee, which has recognized that goals such as inclusive employment can change over time and are difficult to quantify.
Making policy decisions that are ‘informed’ by underemployment from a target that ‘cannot be directly measured’ has the potential to convey an asymmetric inflationary bias in policy,” says Walsh.
Central bankers have simply overlooked their primary role, says Rajan, which is to maintain price stability. “If you tell them, ‘This is your job, focus on that and leave all this other stuff aside,'” he says, “they’ll do a better job.”
Keep it simple
It follows that the simpler the task, the simpler the messaging should be.
Monetary policy works by central bankers manipulating points along the yield curve – essentially the price of money over different periods of time. Central bankers provide signals as to whether interest rates are expected to rise, fall, or go sideways, and traders in financial markets buy and sell massive amounts of bonds accordingly. These movements seep through broader society, affecting pension account balances, business and consumer confidence, and views on future price movements. This is what determines whether central bank policies work or not.
“Monetary policy is 90% communication and 10% action,” says Bank of Thailand Governor Sethaput Suthiwartnarueput.
In early 2022, when the Federal Reserve, European Central Bank and Bank of England changed their forecasts for the economy and inflation, there was a “quite massive failure” to communicate how policy would address these changes, says Athanasios Orphanidis, who served in the ECB’s administration. Council from 2008 to mid-2012. Tightening monetary policy is not difficult. This is a no-brainer for central banks.”
Cross wires can be seen in wild fluctuations in the global bond and currency markets throughout the year. In August, the MOVE index of implied bond volatility – better known as a measure of fear in US Treasuries – jumped to a level it has only surpassed three times since 1988. Investors began demanding a premium for holding AAA-rated Australian bonds after the central bank reversed its pledge to hold interest rates. to 2024 and instead begins its fastest tightening cycle in a generation.
Some central banks issued early warning signals. In October 2021, the Reserve Bank of New Zealand began raising interest rates and the Bank of Canada adopted a more hawkish stance on inflation, halting its bond-buying program. More recently, the Bank of Canada announced that it would begin publishing a record-like summary of deliberations by officials after each policy decision to promote transparency.
By contrast, the Bank of England, already under fire for allowing inflation to spiral out of control, has come under fire for how it treats Britain’s currency and government bonds after Prime Minister Liz Truss’ government proposed a deficit-breaking tax reform. First, the central bank was accused of slacking off before helping to manage the fallout when the pound fell to an all-time low against the dollar, and then investors were stunned when the Bank of England pledged to abruptly end emergency gold purchases. In the end, it was Truss who took the blame, and he quit after only 44 days.
Stephen Miller, former head of fixed income at BlackRock Inc. In Australia and now at GSFM Pty, he has been scrutinizing spreadsheets of economic indicators such as the Cleveland Fed’s CPI measures in a way he has not. for more than three decades. Reason: He doesn’t trust expectations and guidance coming from central banks.
“For me, alarm bells started ringing about inflation long before central bank language changed,” says Miller. “One of the perks of being 61 is that your formative years were a period when inflation was the norm, and oil shocks were the norm. Last year, I felt like I was going back to that period.”
Miller’s report card is harsh: “Bank of Canada, Fed and RBNZ I’d give a C+, the RBA a C- and the rest, including the Bank of England, an F”
For Jerome Hegelian, the “less is more” mantra should extend to what is called Fedspeak. The former Swiss National Bank economist says the number of officials making public statements is confusing. He recommends that the Fed take a lesson from the “very thin” Swiss communications.
After the annual summer gathering of central bankers at the mountain resort of Jackson Hole, Wyoming, Fed officials fanned out for the public circuit. In one 24-hour period, three senior Fed officials spoke about the economic outlook at three different events and with three different tones. Esther George stressed consistency over speed, Christopher Waller indicated his support for a 75 basis point hike at the next meeting, and Charles Evans said he was open to 50 or 75 points. It’s a similar story at the European Central Bank, where key officials were giving speeches in the last week of September alone.
While central banks in most modern economies enjoy day-to-day autonomy, their powers are determined by democratically elected governments. In Australia and New Zealand, for example, the authorities are revising their guidance standards for monetary policymakers.
To get their message across to the public, the ECB has provided cartoons and animated videos, some of which accompany rate decisions and strategy review documents. And Bank Indonesia, which already has a massive following on Facebook and Instagram, now also has its own TikTok account.
Trying to connect with both audiences – the markets and the general public – can sometimes lead to confusion.
The third common central bank prescription: give up forward guidance. This practice, first adopted in the early 2000s, aims to inform the public about the likely direction of monetary policy. The problem: It’s very difficult to predict the future. It can lock policy makers into a certain mindset.
In a speech Oct. 12, Fed Governor Michael Bowman blamed the FOMC’s advance guidance for failing to tackle inflation sooner: “Too loose for too long — even as inflation has been rising and showing signs of a broader base,” she said.
Broken promises can do real damage to investor confidence. GSFM’s Miller cites RBA Governor Lowe’s failed guidance as an example.
Phil Lowe says no rate increases to 2024? Those kinds of messages are dead. “Markets can no longer tolerate central bankers’ rhetoric,” given that they pretended to “look at everything.”
James Athey, chief investment officer of rate management at Edinburgh-based Abrdn Plc, warns that forward guidance won’t be over until central bankers stop talking so much. The sheer number of speeches given by central bank policymakers in a given week, and the apparent willingness of these speakers to explain their personal outlook for the economy and monetary policy, means that even when formal communication is far from specific guidance, there is still a lot to be desired. Markets can hang on to it.”
RBI Governor Shaktikanta Das said in a speech in Mumbai in September that communicating policy objectives becomes more difficult as inflation rises. “It can be very difficult to provide coherent and consistent guidance in a tightening cycle,” he said. Thus, in the current context, central bank communications have become more difficult than actual policy actions.
Of course, central banks will continue to play a crucial role in their economies, even if they back off the rhetoric and scrap more difficult-to-measure goals like promoting inclusive growth. They will continue to act as custodians of financial stability, providing cash when markets plunge. And they will find ways to stimulate economic growth when it is needed again.
But if they heed the lessons of 2022, markets and the public can expect policy communications that are rarer, clearer, and less ambitious—a new era of central bank humility stemming from their failure to prevent an inflationary shock.
Jamrescu and Carson are senior correspondents in Singapore covering the economy and forex/prices, respectively.
— With assistance from Theophilus Argetis, Enda Curran, Kathleen Hayes, Brenisha Naidoo, Garfield Reynolds, Jana Rando, Anoop Roy, Craig Torres, and Sutini Yovgwatana.
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