Written by Matteo Pastorella, edited by Paolo Stohlmann
Section I: Why?, or The purpose of a central bank’s communications.
This paper focuses on the communication systems of the Bank of England (BoE), the US Federal Reserve Board (Fed) and the European Central Bank (ECB), using a comparative approach. The paper will attempt to answer three questions: why do central banks communicate, when do they communicate and to whom do they communicate?
These questions are extremely relevant considering the current financial environment, characterised by the increased independence and expansion of central banks’ mandates, in response to increasingly systemic and complex challenges (as observed during the 2007 financial crisis, the COVID-19 crisis, and the recent European energy crisis). Therefore, if the powers of central banks are generally increasing, understanding their different communication strategies – and how these in turn influence the markets – is more relevant than ever.
Analysing the different communication approaches of the world’s major central banks plays a dual role. On the one hand, it highlights the effects of the communication strategies on financial markets; on the other, it analyses the side of communication aimed at giving more credibility, transparency, and accountability to central banks vis-à-vis civil society. This second side of a central bank’s communication could also be seen as a political tool used by banks to legitimise their more unconventional and controversial monetary and, for certain central banks, fiscal policies.
“Never justify, never excuse,” said Montagu Norman, BoE Governor in the early twentieth century (Moschella & Romelli, 2022). Nowadays, this maxim is no longer followed, because not only have central banks in recent decades increased their information to the public – markets and civil society – to a considerable degree, but at the same time their audience has become more active, demanding (and expecting) more transparency and accountability from central banks’ actions.
Indeed, communication plays a key role in increasing the transparency and consequently the credibility of banks. By increasing credibility, a central bank’s communication enhances the effectiveness and predictability of its micro- and macro-prudential, monetary, and non-monetary policies (Moschella & Romelli, 2022). Therefore, the communication of central banks effectively leads to their conventional and unconventional monetary policies (and in some cases fiscal and banking policies), generating (and altering) expectations in the markets (Gurkaynak et al., 2004).
Central bank communication, for those reasons, has been fundamental during recent global crises – when a strong influence of central banks on markets was needed – for example, during the Global Financial Crisis (GFC) in 2007 and the Covid-19 pandemic (2022). Furthermore, at least in the European case, alterations in the markets due to central banks’ communication could also be observed outside of crises to support ecological transition policies (Couppey-Soubeyran, 2020).
While civil society currently accepts and demands high levels of communication from central banks, historically the opposite has been true. For instance, recalling Cukierman and Meltzer’s (1998) work on the ambiguity and ‘opacity’ of central banks in their preferences and their decision-making procedures to optimise the unanticipated rate of money growth, total central bank transparency would have been detrimental. Indeed, markets and external actors might adapt and respond in advance to central bank decisions if the central bank became totally transparent, freely expressing its preferences and decision-making processes. This might jeopardise the central bank’s capacity to achieve its goals since market expectations can impact economic actors’ behaviour and change the expected outcomes of monetary policy. While the literature has settled on the idea that central banks should communicate to a certain extent, there has been no scientific consensus on how much communication they should employ in order to avoid inflationary biases, although the idea to avoid communication as a possible channel of political influence remains consistent (Mishkin, 2004).
In recent years, different economists and scholars have emphasised the ability of central banks to influence market expectations of future interest rates through communication (Eijffinger & Masciandaro, 2014). Technically, the conventional actions of central banks are mainly based on influencing interest rates in the short term (‘the shorter end of the maturity spectrum’ (Moschella & Romelli, 2022)) through operations in the markets, affecting a bank’s lending rate from the central bank and consequently altering the lending interest rates in the real economy. Thus, changing short-term interest rates on loans from central banks to national banks would lead to a knock-on effect, as national banks will in turn alter the rates they offer on consumer and business loans, altering the investment by the markets.
To influence short-term interest rates during a crisis, it is necessary to manage the communication of central banks, as emphasised by the former Fed Chairperson Bernard Bernanke’s (2004) studies. At the same time, according to the works of Kahneman (2003), there is a limit to the amount of information that a central bank can communicate for the markets to ’digest it properly’. An exaggerated degree of information would damage the expectations of consumers and the market (which are essential in central bank policymaking) or raise market volatility – increasing the frequency and variation of prices in the market (Geraats, 2002).
Nonetheless, the literature has partially moved towards communicative transparency, thus presupposing a certain degree of central bank communication in the markets to influence them. Indeed, central banks utilise their communication ‘power’ to achieve their mandate, as stated by Issing (1999) and Mishkin (2004). Thus, in the next two sections, this article will look at the impact of central bank communication on the markets, and the strategic use of central banks’ communication to achieve the different objectives set by their respective mandates.
All these different approaches expressed by various authors, regarding the degree of communications and the use of it to achieve the central bank’s mandate, can consequently be found, directly or indirectly, in the different aspects of central banks’ communication strategies. This paper focuses on the UK, US, and Eurozone central banks since they have been actively involved in communication activities: the BoE since its independence in monetary policy in May 1997, the Fed since May 1999, adopting a ‘more transparent disclosure practice’ (Ehrmann & Fratzscher, 2005) and the ECB since January 1999, when it began conducting monetary policy decisions in the Eurozone area (Jansen & Haan, 2006).
Section II: When and to whom, or The timing and the audiences of the BoE, Fed, and the ECB.
Communication occurs mainly through policy decision-making committees: the Monetary Policy Committee (MPC) for the BoE, the Federal Open Market Committee (FOCM) for the Fed, and the Governing Council for the ECB.
Intensified communication during times of crisis is a common feature in central banks. Indeed, it is possible to observe the alteration of the Fed Communication Strategy during crises, as shown by FOMC Chairman Bernanke’s statements during the GFC (Ehrmann & Fratzscher, 2005) as the increase of the BoE Governor statements on the UK market during the same periods of crisis (ibid.). In the case of the ECB, there was also a significant increase in the use of communication after the financial crisis of 2008, following the principle of ‘its duty to engage, explain and listen’ (Moschella & Romelli, 2022).
An interesting aspect of central banks’ communication is that, in some particular cases, they can influence markets through their communication alone, without recourse to monetary policies. This phenomenon recalls what the sociologist Robert K. Merton (Merton, 1948) referred to as self-fulfilling prophecies: Mario Draghi’s “whatever it takes” in 2012 during the Eurozone crisis, and the announcement alone to institute Outright Monetary Transactions (OMT) brought immediate effects, reducing the fragmentation of European bond markets, with only initial policy announcements, as observed by Altavilla’s (2014) studies. Central bank communication thus has an important role to play in altering market and consumer expectations.
We should not understand central bank communication as an ‘extraordinary’ event during ‘extraordinary’ times, such as those of crisis. More recently, central banks have also increased communication of their upcoming monetary policies in ‘normal’ times through “Forward Guidance”, as observed by scholar Günter Coenen (2017). However, there is a clear correlation between the convergence of central bank communication and crises, as empirically observable after the GFC in the case studies of the BoE, Fed, and ECB. Indeed, although with differences in intensity, all central banks increase their communication processes to try to ‘calm’ or more appropriately, ‘guide’ the markets during economic and financial turbulence. Nevertheless, the most directly observable differences are in the responses of the markets, where the UK markets rank as less responsive to the BoE and Fed Markets on the different Central bank’s communication strategies (Ehrmann & Fratzscher, 2005).
Therefore, communication by central banks is generally consequential and stimulated when there is an economic environment (as usually during a financial crisis) that brings nominal interest rates close to or equal to zero (zero lower bounds). Nominal interest rates represent the interest rate expressed in monetary terms without taking inflation into account (Evans & Marshall, 1998). When the economy is in a zero lower bound, nominal interest rates are close to zero and thus the central bank cannot further lower rates (the usual response of central banks to stimulate the economy during a period of financial turbulence). In an economic environment characterised by this particular condition, there is an apparent contradiction in the lending sector: although technically, it is cheaper to generate loans due to low-interest rates and thus a reduction in debt servicing costs, the banks’ restrictions on loans in such an economic environment must be taken into account.
In fact, in such an economic situation, national banks will be more reluctant to lend (because they have less expectation of seeing their loans repaid) and at the same time, central banks see their monetary policy capabilities to stimulate the economy become less effective (since they cannot reduce interest rates further).
At this point, in addition to possible liquidity injections and quantitative easing measures in the economic system, which would increase public debt, other more unconventional tools can be used.
Predominantly, a careful use of communication strategy to manage the expectations of economic agents for future inflation rates and lead them to certain economic choices favourable to the economic situation (Coenen et al., 2017).
Usually, interest rates would be changed at the next central bank decision-making meeting. Additionally, during the period following the latest interest rate changes, there has generally been an increase in announcements by the BoE and the Fed, to emphasise their willingness to the previous change in the interest rates and consolidate their economic actions. The ECB’s communication intensity, on the other hand, remained neutral (Moschella & Romelli, 2022). The BoE displayed a particular communication intensity on the economic outlook associated with periods of high market volatility. Nevertheless, the response of financial markets in a situation of economic volatility differs profoundly from the US financial markets, which rely heavily on the FOMC’s statement to the UK financial markets, which are more passive and less responsive to communication strategies employed by the BoE.
Concerning the “whom”, or the audience of central banks, the main distinction is between an ‘expert’ audience (of economic and financial issues) and a ‘non-expert’ one. Therefore, central banks must carefully balance the content aspects of their messages with the target audience (Ehrmann & Wabitsch, 2022). Tentatively, the literature has focused on “experts” as the standard target of central banks’ communication apparatuses, which are necessary for the effectiveness of monetary policies, as Blinder’s studies have pointed out on financial market practitioners and central bank watchers
(Blinder, 2008). Thus, the focus in the literature has been on the established relationship between central bank communication and the prices of financial economic markets, which can be considered from stock market indices to sovereign bonds (Cieslak & Schrimpf, 2019).
Nevertheless, during the implementation of unconventional policies after the GFC, there was a shift of focus towards the ‘non-experts’, the consumers and households, a policy defined as “at least as important as communication with financial markets” (Blinder, 2008). This shift influenced the democratic legitimacy of the central bank and the impact on inflationary expectations. At the same time, the communication of strictly technical information to an audience not specialised in this area raises some issues, such as the weaknesses in the ECB’s ‘Monetary and Banking Dialogues’ with the European Parliament highlight. In this specific circumstance, highly technical and specialised information from the ECB clashes with a ‘non-expert’ audience such as the Members of the European Parliament (MEPs), radically impeding their ability to advance and bring questions through the European Parliament Committee on Economic and Monetary Affairs (ECON) during the so-called ‘Monetary and Banking Dialogues’ with the ECB.
In addition, the constraints of secrecy and discretion imposed by central banks to protect the competitiveness of the financial system make communication generally elusive and opaque in content. Some central banks, such as the Fed, have a historical background of hiding certain information from the political and civic community, as explained by the theory of bureaucratic behaviour (Mishkin, 2022). This concept assumes that the Fed has incentives to conceal its actions to avoid political influence and scrutiny. One former Fed official explained this concept, stating: “Lots of staffers would concede that [secrecy] is designed to shield the Fed from political oversight” (ibid.).
Concomitantly, the Fed, despite strenuously defending its secrecy constraints by delaying the publication of FOMC directives to Congress and U.S. civil society, has become more transparent over the years. Since 1994, it has published the directives taken by the FOCM after each of its meetings, and in 1999, it expressed possible directions toward its future decisions in monetary policy choices. Finally, in 2002, it decided to make the nominal vote on the federal funds rate at FOMC meetings public. Despite this, compared to other central banks, the Fed publishes the minutes of its FOCM steering committee later and does not explicitly communicate its forecasts on the US economy.
Conclusions: Different communicative outcomes based on different roots: looking at the historical institutional perspective.
Certainly, many of the observed differences in the communication strategies of the BoE, Fed, and ECB can be traced back to historical and cultural differences, as well as institutional differences given by their different institutional relationships and mandates.
Indeed, the BoE and ECB, because of their monetary policy strategies based on pursuing price stability mandates (Bank of England Act 1998, Article 11, ECB articles 127 (1) and 282 (2) TFEU), prefer a ‘collegial’ communication strategy through a coherent and unified view of the central banks’ decision-making bodies on their current or future monetary policy choices (Ehrmann & Fratzscher, 2005). This communication strategy aims to influence the markets’ ability to adjust to future interest rates by not showing the diversity of opinions within the committee.
Otherwise, the US Fed’s dual mandate, based instead on maximum sustainable employment and price stability at the same hierarchical level (Born et al., 2011), prefers an ‘individualistic’ (Ehrmann & Fratzscher, 2005) communication strategy. This communication strategy – underlying the different positions of the central bank’s members of the decision-making bodies to the markets and the civil community – makes the central bank’s communication less ‘unitary’ but more ‘transparent’, focusing on the monetary policy decisions’ risks and allowing the market and civil society to gain more information about them.
Additionally, it is paramount to observe that the Fed’s ‘individualistic’ communication strategy is under the interference of other powers – the legislative and executive ones – of the US government (Ehrmann & Fratzscher, 2005). Indeed, the US Congress carries out considerable interference in its upper chamber. The seven members of the Board of Governors, one of the major decision-making bodies of the US central bank, are appointed by the President of the United States and subsequently confirmed by the Senate. In this way, since the Fed’s communication is highly exposed to the markets and American civil society, and its formation influenced by the President, there is, therefore, an ‘initial’ and ‘final’ control of the work of the US central bank, configuring it as much less ‘independent’ than the BoE and ECB.
To conclude, having distinguished three different central banks’ communication strategies, and elaborated on why they have been historically and institutionally preferred to others, it is possible to understand how central banks use communication to influence markets and consumers’ expectations. Nevertheless, there is no single communication strategy to achieve this goal. This research work has sought to contribute to further developments on this controversial and debated, but undoubtedly relevant, topic.
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