Here is a long note from Citi’s William Buiter on central bank forward guidance. It is a good overview of how forward guidance can be “cheap talk” and in order for markets to take central banks seriously, contingent changes to monetary policy (like inflation or unemployment at certain thresholds) are the only serious option.
The best approach to signaling longer-term policy intentions in an operational manner typically has three components.
First, commit to the regular publication and updating of longer-term forecasts of the target variables, of any additional nominal or real thresholds, knockouts or triggers that define the central bank’s reaction function for each of its instruments, and of the instruments themselves.
Second, reach an agreement that at most one member of the monetary policy making committee, presumably its chair, speaks or writes publicly about the likely future paths of the policy instruments – rates, QE, or whatever. The other members can of course still discourse in public about the principles of monetary policy and the history of central banking.
Third, give the central bank skin in the game by requiring it to issue or purchase material amounts of financial instruments on which it will lose money if interest rates depart from the forward guidance-consistent levels – financial hostage instruments. If possible, link the pay of the monetary policy makers at least in part to the performance of these instruments.
Hat tip to FT Alphaville who wrote about this yesterday.
It is interesting that despite Buiter thinking that policy rate changes by committee is a good idea, he still thinks that only one person – the chair or governor should be communicating this stuff.
The US Federal Reserve has a whole lot of people making public comments – all of the regional governors for example – and I’m not sure that’s optimal.
Different Federal Reserve Banks have different ways of looking at the world, and if market participants can cherry pick forward guidance from who they like on the Board of Governors that’s problematic.
With respect to the hostage instruments he talks about, I don’t think that’s appropriate. The people best equipped to deal with these sorts of strategies are on trading desks, not on the capped salaries of the public sector.
It would be far too much to expect there to not be significant losses on the learning curve of those sorts of policies, in the vein of massive foreign exchange market intervention losses that have occurred in the past when countries tried to defend fixed exchange rates and went broke.
I think New Zealand is doing OCR changes the right way – the buck stops with the Governor and he is also the person who fronts the press conferences. It’s a shame they’re anointing themselves as arbiters of what loans are good and what loans are bad though.