Sheryl Kennedy: Transparency - the more, the better?
Remarks by Ms Sheryl Kennedy, Deputy Governor of the Bank of Canada, to l'Association
des femmes en finance du Québec, Montréal, Quebec, 8 January 2008.
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Transparency is the cornerstone of a well-functioning financial system. It's an issue that has
been getting a lot of attention, and deservedly so, as we consider what has gone wrong in
the market for asset-backed commercial paper. I'll be happy to take any queries you might
have on this topic during the question and answer session following my remarks. But first, I
want to talk to you about transparency in central banking and in setting monetary policy.
Then, I'll close my remarks with a review of the changing monetary policy outlook over the
past six months, which serves to illustrate my key points.
So, what has been done, and what more can we do to improve transparency in monetary
policy? Are there any limits? I'll approach these questions from three perspectives:
transparency about the Bank's policy framework; transparency about the inputs, the
processes, and the reasoning behind monetary policy decisions; and transparency about our
assessment of the outlook for the economy and monetary policy.
That last element, disclosing more of the Bank's assessment about the outlook, including
forward-looking statements about monetary policy actions, is particularly tricky and really
tests the limits of transparency. Nevertheless, it is in this area that there may be the most
room to increase transparency. But first, we must figure out if it would be beneficial to provide
more information for market participants, firms, and individuals. More fundamentally, would it
improve the effectiveness of monetary policy? And if we find that it would be beneficial, how
can we convey this information so that it would be readily understood? Or more importantly,
how can we convey this information in a way that will not be misunderstood?
At the Bank of Canada, we do not believe in constructive ambiguity, nor in saturating the
market with a lot of information that has no clear message. Real transparency involves
judgment: communicating what is important, what clarifies, and not what obscures. I'll have
more to say on this in a few minutes.
Why be transparent?
But first, let's back up one step to look more closely at just why transparency is so important
to the conduct of monetary policy. It has become very clear over time and with experience,
that monetary policy is most effective when the policy objective is clearly understood and
accepted. When consumers and savers, business owners, and financial market players, all
understand the Bank of Canada's policy objective - and believe that it is attainable - then
they can make better long-term plans and decisions. And when everyone expects this target
to be maintained, and acts accordingly, then the target becomes self-reinforcing.
But the benefits of transparency don't stop there. I believe that transparency also helps us to
make better decisions. The extra rigour that comes from holding the rationale behind our
decisions up to external scrutiny leads to better results.
Finally, the Bank of Canada is a public institution - funded by, and accountable to, the
taxpayer. Information and analysis gathered in the context of the Bank's business should be
considered a public good - except when the release of such information would compromise
the implementation of the Bank's mandate.
Are there limits to transparency?
In general, more transparency is better than less. But this does not mean that there are no
limits. First, there is the need to protect the confidentiality of some information and analysis
that is given to the Bank by outside parties, be they public- or private-sector institutions.
Indeed, public release of third-party, confidential information would jeopardize the central
bank's ability to get all the information it needs to make good monetary policy decisions.
Second, there is the need to protect the integrity of some internal policy deliberations. For
example, the public release of policy advice and recommendations could stifle the free
debate and consensus building that is necessary for sound policy-making. We want to hear
all aspects of an argument, but it could be hard for staff members to play devil's advocate,
knowing that such a position will be made public and could be taken out of context. And
certain information should not be released while policy is still being developed, or has not yet
had its full effect. In such cases, premature transparency could lead to misinterpretation or
be acted on inappropriately, which could derail good policy intentions and could potentially
be damaging to Canada's economic interests.
Third, there is the need for good quality information. Providing useful, relevant information is
far more important than dumping a large quantity of information of questionable quality. Too
much information can actually cloud what is important. As a result, actions and decisions can
become less transparent, because the really important, effective, and relevant information
gets lost in the minutiae.
Good quality information must not only be accurate, it must also be communicated clearly
and simply, so that it won't be misunderstood. This is especially germane when we try to be
transparent about our assessment of the outlook by publishing our economic projections,
along with the risks and uncertainties surrounding them, and forward-looking statements
about possible future policy actions.
Transparency in setting monetary policy
Debates about the limits to transparency for effective monetary policy are certainly not
unique to the Bank of Canada. Central banks around the world are still learning the best
ways to communicate monetary policy. This is an important element of the art, rather than
the hard science, of central banking. I believe that we at the Bank of Canada have made
great strides in this area.
So let's now take a closer look at the issue of transparency in setting monetary policy from
the three perspectives that I mentioned at the outset: transparency about our policy
framework; transparency about the inputs, the processes, and the reasoning behind
monetary policy; and transparency about our assessment of the outlook.
The Bank made a major leap forward in increasing transparency about our policy
framework when we adopted an explicit inflation target in 1991. This target provides a clear
objective for monetary policy, which has helped to anchor financial and economic decisions.
It makes it easy to measure the success of monetary policy and to hold the Bank
accountable for its actions. Canadian individuals and firms can align their savings,
investment, and spending plans with a common inflation-control objective. If inflation
persistently deviates from the target, we are committed to explaining the reasons why, what
we will do to return it to target, and how long we expect the process to take. Previously, when
we targeted monetary aggregates, for example, there was ambiguity about what the bank
was trying to achieve, and we were not always clear about the implications of such a target
for output, inflation, and interest rates.
Now, as well as being clear about our objective, we are also being transparent about our
assessment of the factors that influence inflation and about how we implement monetary
policy. We conduct monetary policy in a symmetric way, worrying as much about the trend of
inflation falling below target as we do about it rising above target. To keep inflation on target,
we try to keep the economy operating near its full capacity. When the demand for goods and
services pushes the Canadian economy against the limits of its capacity, and inflation is
poised to rise above target, the Bank will raise interest rates to cool off the economy. And
when the economy is expected to operate below its production capacity, and inflation is
poised to fall below target, the Bank will lower interest rates to stimulate growth. We also
factor in shocks that directly affect inflation.
Because we target domestic inflation, we have a floating currency. A central bank cannot
successfully control both the domestic and external values of its currency at the same time.
And a flexible exchange rate is an important price signal of changing global and domestic
circumstances that can help to prompt and facilitate necessary adjustment.
This is our paradigm for the conduct of monetary policy, and we have been so transparent
about it that we have devoted entire speeches and published a great deal of staff research
on the topic. We do this so that a careful observer can understand just how monetary policy
will adjust to changing circumstances.
Our inflation target is established under an agreement with the federal government. When
this is reviewed periodically, we look for ways to improve the conduct of monetary policy
based on recent experience and research in order to clarify aspects of our framework. In the
most recent review, for example, we examined how to deal with asset-price bubbles and
looked at the appropriate time horizon for returning inflation to target following an economic
or financial shock. In preparation for the next review of our inflation targeting agreement in
2011, we are conducting an intensive research program into possible improvements to our
policy framework. Specifically, we are looking into the merits of a lower inflation target and
price-level targeting.
Now, let's look at transparency about the inputs, the processes, and the reasoning
behind monetary policy decisions. Just a little over a decade ago, the Bank didn't even
issue a press release when it made an interest rate decision. Now, our rate announcements
are widely anticipated. There is a very high level of interest, stretching from households to
office towers, in what the Bank of Canada has to say on interest rates, inflation, and the
economy.
This interest is at least partly the result of a series of measures taken by the Bank to increase
transparency. After the introduction of the inflation target, we moved in 1994 to become more
open about how we implement monetary policy by targeting the overnight interest rate. A
further major step towards greater transparency came in 1995 when we began to publish a
regular Monetary Policy Report, and later added MPR Updates, to provide a window for
financial markets and the general public into the analysis behind our conduct of monetary
policy. Soon after that, the Bank began to publicly announce interest rate changes through
press releases. These steps helped to increase understanding and acceptance of the Bank's
policy objective.
Still, there was a lot of ambiguity and uncertainty in financial markets about exactly when the
Bank of Canada might change its monetary policy stance. So, in 2000, we decided to set
eight fixed dates each year for interest rate announcements, regardless of whether rates
were changed or not. This commitment to a timetable provided more certainty for markets, a
better focus for external commentators to develop and expand their own views on the
economic outlook, and regular opportunities for us at the Bank of Canada to review the
accumulation of data and to update our views about the outlook for inflation and the
appropriate course for monetary policy. This extra focus and rigor has, in my opinion,
improved our decision-making process. Of course, the Bank retains the option of moving
between dates in extraordinary circumstances, an option that has been exercised only once
since fixed announcement dates were established.
Most of the information and analysis that the Bank uses when it makes monetary policy
decisions are based on data that are also available to the public. There was a time when one
such input - our Business Outlook Survey - was not publicly available. But after we
conducted research to determine which of our survey questions provided the most useful
information, we began to publish the results of those questions. The motivation was not only
to help improve the public's understanding, but also to be as open and transparent as we
could, given our responsibilities as a public institution. We continue to examine whether we
can make public more of the inputs to monetary policy, without compromising the
policymaking process. Indeed, in the upcoming January Business Outlook Survey, we will be
including responses to two additional questions on past sales and credit conditions.
I'll now turn to the third perspective, which is transparency about our assessment of the
outlook for the economy and monetary policy. Because it can take as long as two years
for monetary policy actions to have their full effect on inflation, we must always be looking
well into the future. So, the questions become: how can we effectively communicate the kind
of uncertainty and the many risks that any views about the future must always include? How
can we talk openly about possibilities and risks in a way that won't be misunderstood? It
would not aid transparency if our assumptions and projections of what might transpire -
assessments which are, by their very nature, conditional - were misconstrued as more
concrete predictions or commitments.
At the Bank of Canada, the Governing Council sets out its base-case projection for inflation
and growth in the Canadian economy four times a year in our Monetary Policy Reports and
Updates. This base-case projection reflects Governing Council's best judgment about the
most likely outcome, based on a number of assumptions. Over the years, we have become
increasingly transparent in describing our projections, and the underlying assumptions. This
January, we will include in our Update projection tables on global economic growth - tables
that previously had only been included in full Monetary Policy Reports.
We have provided more detail about how we see the economy unfolding, what forces might
affect inflation, and what assumptions we have had to make about more volatile or uncertain
variables. This, in turn, helps to explain the reasons behind our most recent decisions and
provides some insight into possible future actions.
The base-case projection embeds changes in the policy interest rate that would be
necessary to achieve our 2 per cent inflation target over the medium term. We describe the
direction and magnitude of that interest rate path in a few words, in Chapter 4 of the
Monetary Policy Report
and when we update the base-case projection in the Update. We
may also give an indication of the time horizon for this path.
We have also become more forthcoming in recent years about the risks that we see
surrounding the base-case projection and whether we think these risks are balanced or not.
Our policy rate statements, in press releases and in the Overview section of the Monetary
Policy Report and Update, reflect our best judgment in the context of the overall outlook at
that time, including the balance of risks. But that, too, is no guarantee that the future will play
out the way we expect.
There are several ways we might consider providing more transparency about the risks and
uncertainties around our base-case projections. Some central banks use fan charts showing
confidence intervals that can suggest the extent of uncertainty around a particular factor in
the overall forecast. Another approach is to publish complete alternative scenarios in addition
to presenting a base-case projection. And some academics have called for more
transparency by sharing the monetary authorities' probability estimates of different risks.
Examining some of these possibilities is in our work plan for the year ahead.
What is not in our work plan is the use of stock words and phrases to signal policy intentions.
This isn't our practice at the Bank of Canada. Instead, we try to spell out the situation as we
see it. We set out our base-case projection for the economy and the key risks; we make clear
the indicators that we're closely following; and by being clear about our paradigm, we try to
help a careful observer to better understand how monetary policy could evolve, depending
on changing circumstances.
But we count on outside observers to do their own analytical heavy lifting as well. In
preparing for our interest rate decisions, we look at market prices, external commentary, and
other analysis. We rely on observers to provide their own perspective on the outlook. If our
views differ substantially from the consensus of external observers, we might consider either
redoing our own analysis, seeking out further information, or communicating more explicitly
our views and analysis to help those observers to understand the factors that we consider to
be important. As I have said on many occasions, if you are considering placing a bet
between what you think we said we were going to do and what you think we ought to do, I'd
go with the latter.
Outlook for the Canadian economy and inflation
So, let me conclude by looking at the evolution of monetary policy over the past six months.
It certainly has been a fluid situation, and an excellent example of how forward-looking
assessments can change quite rapidly.
Back in July, we raised our policy rate by a quarter of one percentage point because we
judged that the economy was operating, at that time, at a level further above its production
potential than had been projected at the time of the April Monetary Policy Report. As we
expected both total and core CPI to remain above 2 per cent, we concluded that some
modest further increase in the overnight rate might be required to bring inflation back to
2 per cent over the medium term.
By the end of the summer, the situation had changed in many respects. The Canadian
economy was operating even further above its production potential than estimated in July,
which was putting upward pressure on inflation. Developments in financial markets had led to
some tightening of credit conditions for Canadian borrowers, however, which would temper
the growth in domestic demand. And the U.S. economic outlook had also weakened. This,
together with a higher assumed level for the Canadian dollar, suggested that there would be
more drag from net exports in 2008 and 2009 than previously expected. Given these
developments, we held our policy rate steady through September and October. We identified
several risks to the outlook for inflation and judged them to be roughly balanced, with
perhaps a slight tilt to the downside.
In the event, the downside risks prevailed. When we re-examined our monetary policy stance
early in December, the Canadian economy was growing broadly in line with the Bank's
expectations, reflecting in large part the underlying strength of domestic demand. But both
total CPI and core inflation were now below the Bank's expectations, reflecting increased
competitive pressures related to the level of the Canadian dollar. In addition, other
developments since October suggested that the downside risks to our inflation projection had
increased. Global financial market difficulties had worsened, tightening credit conditions
further, and there was an increased risk to the prospects for the demand for Canadian
exports, since the outlook for the U.S. economy had weakened further. So, on 4 December,
we judged that the balance of risks had shifted to the downside, and we lowered our target
for the overnight rate to 4 1/4 per cent.
Now, as we prepare for our next interest rate announcement on 22 January, and our
Monetary Policy Report Update two days later, we are preparing our regular quarterly
economic projection and risk assessments, so that we can fully assess the implications of all
economic and financial developments since the October Report, and set the appropriate
course for monetary policy.
Conclusion
At the Bank of Canada, we are very interested in any ideas you might have on this topic of
transparency in monetary policy - what the limits are and how transparency can continue to
be improved. In my view, generally, more is better. Apart from the need to protect
confidential information and not compromise the policy-making process, the true limits to
transparency in monetary policy lie in communicating effectively in the face of uncertainty, a
skill which we are constantly striving to master.