Central Bank Transparency andCentral Bank Transparency andCentral Bank Transparency and Central Bank Transparency and Central Bank CommunicationCentral Bank Communication

Monetary PolicyMonetary Policy -- an Art of Managing Expectationsan Art of Managing ExpectationsMonetary Policy Monetary Policy an Art of Managing Expectationsan Art of Managing Expectations

k kk kMarek RozkrutMarek RozkrutNational Bank of PolandNational Bank of Poland

XII REUNIÓN DE COMUNICACIONES XII REUNIÓN DE COMUNICACIONES DE BANCA CENTRALDE BANCA CENTRALDE BANCA CENTRALDE BANCA CENTRAL

2121--23 de noviembre de 200723 de noviembre de 2007LIMA PERULIMA PERU

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LIMA, PERULIMA, PERU

OutlineOutline

• Driving forces of transparency and communicationcommunication

• Monetary policy as an art of managing expectationsexpectations

• Communication channels – from “words” to MP effectivenessMP effectiveness

• Empirical evidence on the effectiveness of CB communication

• Limits of transparency• Conclusions

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• Conclusions

A wind of changeA wind of changeA wind of change …A wind of change …

GGreenspan:Since I have become a central banker I have l d t bl ith t i h Iflearned to mumble with great incoherence. If I seem unduly clear to you, you must have misunderstood what I said (1987)misunderstood what I said (1987)

15 years later …Openness is an obligation of a central bank in a free and democratic society (2002)

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From secrecy to transparencyFrom secrecy to transparencyy p yy p y

• Driving forces of transparency and i ticommunication:

– Move away from XR pegs and monetary targetsIT ill i d b t f• IT spill-over accompanied by a movement from secrecytowards transparency – a vital component of monetary policy (Fry et al. 2000).

A d th t d ti– And the trend continues …

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Transparency increase over timeTransparency increase over time

100 CBs sample:

• In 89 transparency improved• In 89 transparency improved• In 11 transparency levelremained unchanged

• No country reduced itstransparency !

5Source: Dincer and Eichengreen (2007)

NBP communication NBP communication –– selected issuesselected issues

• 2004: Inflation Report reform:– No longer a historical document

Published on the day following the MPC decision both in– Published on the day following the MPC decision both in Polish and English

• Since 2004 inflation and since 2005 output projections have been publishedprojections have been published

• May 2007: NBP began to publish minutes• Press releases• Press releases

– economic story instead of statistical data– Monetary policy bias introduced, later replaced with the

b l f i k t

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balance of risks assessment

From secrecy to transparencyFrom secrecy to transparencyy p yy p y

• Driving forces of transparency and i ticommunication:

– Move away from XR pegs and monetary targetsIT ill i d b t f• IT spill-over accompanied by a movement from secrecytowards transparency – a vital component of monetary policy (Fry et al. 2000).

A d th t d ti– And the trend continues …– Need for accountability, not least in countries with

independent central banks and lags between MP p gdecisions and the target variable

• Rise in CB transparency in Latin America, Eastern Europe and Asia coincided with the third wave of democratization

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and Asia coincided with the third wave of democratization

From secrecy to transparencyFrom secrecy to transparencyy p yy p y

• Driving forces of transparency and i ticommunication:

– From single decision-maker to committeesE di lit t th b fit f– Expanding literature on the benefits of transparency

– Media coverageMedia coverage– An increasing awareness of the critical role of

private sector EXPECTATIONS in the MP conduct• reinforced by financial markets development

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• Monetary policy – an art of managingMonetary policy an art of managing private sector expectations

I t i d t i li d i h t– In most industrialized economies – short-term interest rate = the main instrument of monetary policy (Bernanke et al 2004)monetary policy (Bernanke et al. 2004) little powerful

– The importance of private sectorThe importance of private sector expectations about the future path of interest rates (Svensson 2005)

– “Not only do expectations about policy matter, but (…) very little else matters”

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(Woodford 2005)

Effective management of private sector Effective management of private sector expectations depends, expectations depends, inter aliainter alia, on:, on:

• Policy-maker communication abilities– Lessening or eliminating informational asymmetries

p pp p

Lessening or eliminating informational asymmetries between CB and the private sector

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Disclosing more information Disclosing more information = i d t p ?= i d t p ?= increased transparency?= increased transparency?

• Limited ability to process information y peffectively (quantitative and complexity limits -Kahnemann 2003)– CBs know that – using different communication tools

depending on the target audienceToo much information may kill informationToo much information may kill information

• Crucial elements of transparency: clarity & common understanding (Winkler 2000)common understanding (Winkler 2000)

• Critical role of communication (Issing 2005; Woodford 2005)

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)

Effective management of private sectorEffective management of private sectorEffective management of private sector Effective management of private sector expectations depends, expectations depends, inter aliainter alia, on:, on:

• Policy-maker communication abilities– Lessening or eliminating informational asymmetries

between CB and the private sectorbetween CB and the private sector– The public’s understanding of current and future policies is

critical for the effectiveness of MP policy

Credibilit• Credibility

C dibilit EffectiveCredibility Effective communication

Matching words

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Matching words with deeds

From ”From ”wordswords ” via ” via expectations expectations to more to more effective MPeffective MP –– communication channels:communication channels:effective MP effective MP communication channels:communication channels:

I th h t I d di t bilit f MP– In the short run – Increased predictability of MP decisions lower risk and volatility in financial markets smoother adjustment of the economy to MP actions

– In the long run - communicating objective and strategy anchoring long term expectationsstrategy anchoring long-term expectations wage-setting and pricing behavior, increased CB flexibility in response to economic disturbances (King 2005)

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From ”From ”wordswords ” via ” via expectations expectations to more to more effective MPeffective MP –– communication channels:communication channels:effective MP effective MP communication channels:communication channels:

• A special role of communication in countries with a short-track record of low and stablewith a short track record of low and stable inflation:– Inflation expectations very adaptive Monetary

policy more difficult (Orphanides and Williams 2002).

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From ”From ”wordswords ” via ” via expectations expectations to more to more effective MPeffective MP –– communication channels:communication channels:effective MP effective MP communication channels:communication channels:

– In the short run – Increased predictability of MP– In the short run – Increased predictability of MP decisions lower risk and volatility in financial markets smoother adjustment of the economy to MP actionsMP actions

– In the long run - communicating objective and strategy anchoring long-term expectations

tti d i i b h i i d CBwage-setting and pricing behavior, increased CB flexibility in response to economic disturbances (King 2005)

– Aligning market expectations more closely with the CB own plans and projections. Influencing the yield curve and other asset prices C & I decisions

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improved MTM

Empirical evidence on the effectiveness of CB Empirical evidence on the effectiveness of CB ppcommunicationcommunication

• Significant and increasing role of communication in g gMP conduct, but still relatively scarce empirical literature on the effectiveness of central bank communication:communication:– Mostly for FED, ECB, and BoE, e.g. Ehrmann and Fratzscher

(2005); Kohn and Sack (2003); Gurkaynak et al. (2005; 2006); G l h (2005) H i d Ul i h (2005) R dGerlach (2005); Heinemann and Ulrich (2005); Reeves and Sawicki (2007)); for Sweden – Andersson et al. (2001); for 6 developed countries: Conolly and Kohler (2007)F t di f i t i / t iti i– Few studies for emerging countries / transition economies

• Rozkrut, Rybiński, Sztaba, Szwaja (2007) for CEEC3• Gabriel and Pinter (2006) for Hungary

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• Rozkrut (2007) for Poland

Measuring communicationMeasuring communication⎧

⎪⎩

⎪⎨

⎧=MP

tST +1 inclination of tightening monetary policy -1 inclination of easing monetary policy

⎩

⎪⎨

⎧=EC

tST +1 improved economic outlook

⎪⎩

⎨t

⎧

-1 weaker economic outlook

⎪⎩

⎪⎨

⎧=FX

tST +1 indication of undervalued exchange rate -1 indication of overvalued exchange rate

⎪

⎪⎨

⎧=FP

tST +1 statement criticizing fiscal situation

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⎪⎩ -1 statement favoring fiscal situation

EGARCH(1,1) framework:EGARCH(1,1) framework:( )( )

MPt

MPECt

ECttit

iit STSTXMSCrr ββφβδβ +++++= −∑ 10 )(

tMPt

MPECt

ECFPt

FPFXt

FX CCSTST ελλββ +++++

),0(~| 1 ttt hN−ψε

rt – daily change in 3M, 6M,12M money market rate, two- and five-year bond yields (in percentage points); change in the exchange rate and stock market index (in per cent: difference in log)

The vector Xt of controls includes: surprise component of various macroeconomic news (macj,t – difference between the actually released figure of jthvariable and market expectations (the median expectations obtained through a Bloomberg or Reuters surveys), normalized by its standard deviation), day-of-the-week effects foreign interest rate (for domestic interest rate as a dependent

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week effects, foreign interest rate (for domestic interest rate as a dependent variable), interest rate disparity (for XR) and change in the MSCI index (for stock market index).

EGARCH(1,1):EGARCH(1,1):( )( )

⎞⎛

MPMPECECFXFXMPMPECEC

tROI

tvoting

ttt

t

t

tt

CCSTSTSTY

ROIVotingMSChhh

h

χχγγγϕ

γγγγεγεγγ

++++++

+++++⎟⎟⎠

⎞⎜⎜⎝

⎛++= −

−

−

−

−413

1

12

1

110 )ln()ln(

tttttt CCSTSTSTY χχγγγϕ ++++++

Votingt i ROIt – dummy variables equal 1 on the day of publication of MPC voting records and Inflation Report respectively and 0 otherwise

Vectors Y includes absolute values of variables included in the vector XVectors Yt includes absolute values of variables included in the vector Xt.

More details on the results – additional slides during Q&A session

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More details on the results additional slides during Q&A session

Empirical evidence on the effectiveness of CBEmpirical evidence on the effectiveness of CB

• CB communication does affect financial asset

Empirical evidence on the effectiveness of CB Empirical evidence on the effectiveness of CB communicationcommunication

• CB communication does affect financial asset prices in the desired direction

• Different communication strategies and similar effectivenesseffectiveness

• Financial markets most sensitive to monetary policy inclination statements– Information asymmetry

• Statements most influential when made by (Rozkrut 2007):)– Policy-makers who win majority of voting– Those who match their words with deeds– Relatively less talkative policy-makers

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y p y

Communication vs monetary policy decisionsCommunication vs monetary policy decisionsCommunication vs monetary policy decisions Communication vs monetary policy decisions predictabilitypredictability

m

∑

ttjj

macjtt macratioconsensusratiostockMSC ελβββ ++++= ∑

=

)(__ ,1

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∑=

−=n

i

STitt

MP

SUMratiostock1

)(_Number of statements in the inter-meeting period:

n – the number of days that have gone by since the previous meeting day

MPSTSUM STitSUM − - the number of statements on day t

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∑ ∑= =

−

n

i

k

j

MPjitST

1 1, ))(( The net-balance of monetary policy

inclination statements in relation to the

∑=

−

= == n

i

STt

i jt

MP

SUMratioconsensus

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1 1

)(_ total number of statements in the inter-

meeting period (Rozkrut et al. 2007)

01 1

More consistent dovish communication

More consistent hawkish communication

0-1 1

consensus_ratio1

STSTN N

MPq

MPp −∑ ∑

−

(Jansen de Haan 2004;Alternatively:

where: N = stock ratiot

)(21

_2

1 1

DNratiodispersion p pq

t

−= = += (Jansen, de Haan 2004;

Ehrmann, Fratzscher 2005)

where: N stock_ratiot

D = 1 if N is an odd number

D = 0 if N is an even numberIncreasing dispersion of statements

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10 dispersion_ratio

Empirical evidence on the effectiveness of CBEmpirical evidence on the effectiveness of CBEmpirical evidence on the effectiveness of CB Empirical evidence on the effectiveness of CB communicationcommunication

• CB communication does increase MP predictability (Ehrmann&Fratzscher 2005; Rozkrut et al. 2007)Predictability increases in the number of statements• Predictability increases in the number of statements made in the inter-meeting period

• Predictability decreases in the dispersion of y pcommunication– However, it does not necessarily imply that policy-makers

should avoid going public with different views (e.g.should avoid going public with different views (e.g. individualistic committees)

• Informative value of voting records for future MP decisions (Gerlach-Kristen 2004; Rozkrut 2007)

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decisions (Gerlach Kristen 2004; Rozkrut 2007)

Transparency Transparency –– what next?what next?

• Will move in the direction of greater transparency prove durable? – The answer, in part, depends on the

consequences– Empirical evidence on the effectiveness ofEmpirical evidence on the effectiveness of

communicationBUT …

Li it f t ?• Limits of transparency?– Feasibility

Desirabilit (C ki 2007)

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– Desirability (Cukierman 2007)

Limits of transparencyLimits of transparencyLimits of transparencyLimits of transparency

• Feasibility: – Limited ability of economic agents to process

information effectively (Kahnemann 2003)– CB opaqueness about the structure of theCB opaqueness about the structure of the

economy:• potential output• measurement problems (Orphanides 2003)• measurement problems (Orphanides 2003)• trade-off between accuracy and transparency

– Uncertainty about the MTM lags and the impact of MP t ti (C ki 2007)MP on expectations (Cukierman 2007)

– Opaqueness about the CB loss function:• infeasible (Vickers 1998), not least in committees

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• feasible (Svensson 2002; 2003)

Limits of transparencyLimits of transparencyLimits of transparencyLimits of transparency

• Desirability:I f i b h fi i l bili ( i d– Information about threats to financial stability (may induce a run on the banks, etc.)

– Openness about disagreement within the CB:Press highlight conflicts• Press highlight conflicts

• Short-term political and personal career factors• Speaking with one voice? Not always a good idea

– Announcing policy rule?– Announcing policy rule? • It is hard or even impossible to formulate in advance the

course of action to be followed by the CB (Greenspan 2004) –commitment may unnecessarily tie the CB hands, but:

• Conditionality of the commitment (Woodford 2005)– How much should CB talk about uncertainty?

• Trade-off between being clear and concise and between full openness about CB’s own limitations and internal procedures

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openness about CB’s own limitations and internal procedures

Limits of transparency in MorrisLimits of transparency in Morris--Shin modelShin model

• Noisy CB communication may, by crowding out private information, lead to sub-optimal market reactions (Morris and Shin 2002)– CB withholding some information or reducing its precision– Limiting the degree of publicity (Cornand and Heinemann

2006)BUT• BUT:– M-S conclusions put into question by Svensson (2006) and

Woodford (2005)P i i f th i t t bli i l i li ht f– Precision of the private sector vs public signal in light of Romer&Romer (2000)

– Firms have limited capacities to process information or face costs of acquiring, absorbing and processing

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q g, g p ginformation (Sims 2003; Reis 2004)

Limits of transparency in MorrisLimits of transparency in Morris--Shin modelShin model

• Empirical testing of the M-S argument (Ehrmann and Fratzscher 2007)Effectiveness of communication may depend on the• Effectiveness of communication may depend on the market environment:– Communication during the black-out periods reduces

predictability of CB decisions (markets are then overly attentive)

– Communication may be detrimental under low market uncertaintyuncertainty

• Results very preliminary and more evidence needed before firm conclusions are drawn

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Transparency Transparency –– what next?what next?

• Varying degree of transparency many CBs still have to close the gaphave to close the gap

• Many of the limits are not fixed:– More and more CBs publish minutes and voting records

I i b f CB t t t bli h t l t– Increasing number of CBs start to publish or at least comment more explicitly on the future interest rate path

• CB communication strategy continuously amended:Rik b k d i i 11 M 2007 i h– Riksbank decision on 11 May 2007 to increase the frequency of press conferences and to reveal voting of individual committee members, but at the same time it announced that:The Executive Board has come to the conclusion that there is not normally any reason to indicate how the repo rate will be set in speeches and press releases issued prior to the monetary policy meetings. Our assessment is that it is

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y p y genough to signal our intentions clearly in connection with the seven monetary policy meetings held every year

ConclusionsConclusions

• Increasing awareness of the critical role of CB transparency and communication in the MP conduct

• MP as an art of managing expectations –communication abilities of paramount importance

• Effectiveness of CB communication proved• Effectiveness of CB communication proved empirically

• Transparency trend unlikely to be reversed• Limits of transparency – many of them not yet

approached, some may be extended, but some already binding

• Communication strategy continuously adjusted to changing conditions

MP still an art not yet in the stage to be replaced

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MP still an art, not yet in the stage to be replaced with the "science of monetary policy”

Report on the Costs and Benefits of Poland’sReport on the Costs and Benefits of Poland’sReport on the Costs and Benefits of Poland s Report on the Costs and Benefits of Poland s Adoption of the EuroAdoption of the Euro

O i lt ti ith• Ongoing consultations with:– Representatives of employers, employees, academia, media, wide

range of different institutionsO i• Open seminars

• Irrespective of whether you are skeptical or enthusiastic about euro adoption you’re invited

• Let people be a part of the decision-making process• Gaining public support for the Report increasing the

probability that its conclusions will be implemented and thus that the Report will actually influence the ultimate net balance of euro membership

• Yet another example of transparency and communication b fit

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benefits