Jens Weidmann: Central bank communication as an instrument of
monetary policy
Lecture by Dr Jens Weidmann, President of the Deutsche Bundesbank and Chairman of the
Board of Directors of the Bank for International Settlements, at the Centre for European
Economic Research, Mannheim, 2 May 2018.
* * *
1 Introductory remarks
Professor Wambach,
ladies and gentlemen
I would first like to thank you very much for inviting me to speak here at the Centre for European
Economic Research as part of the "First-Hand Information on Economic Policy" series of
lectures.
When I hear the phrases "economic policy" and "hand", I can't help but think of Harry Truman's
famous demand for a one-handed economist. By always assessing everything "on the one hand
... on the other hand", the economists clearly got on the then US president's nerves.
In this case, it goes without saying that "First-Hand Information on Economic Policy" has little to
do with "one-handed" economists.
No, "first-hand" in this sense means "directly from decision-makers". With that definition in mind,
as Bundesbank President and member of the ECB Governing Council, I should obviously talk
about monetary policy.
It has now been seven years since I delivered my first speech as Bundesbank President, and I
have given a few more in the meantime. I haven't been keeping count, but the database of public
speeches on the Bundesbank website now contains more than 150 entries.
Not all of my speeches, but a large number of them, are partially or even primarily about matters
of monetary policy. Speeches have become a vital means of communication for monetary policy
decision-makers. The six members of the ECB Executive Board alone have given 150 public
speeches over the past year. And speeches are just one means of communication. Other
channels of central bank communication are interviews, press conferences, and regular
publications of reports.
Close attention is paid, in particular, to the ECB President's introductory statement at the
beginning of the press conferences following ECB Governing Council monetary policy meetings.
ECB watchers scrutinise every word. Changes in communication are very keenly noticed and
analysed. And it is not only what is said but also what is left unsaid that can send a message.
"One cannot not communicate." From that perspective, this well-known quote by communication
theorist Paul Watzlawick also applies to monetary policy.
In my speech today, I would like to discuss the significance of communication as an instrument
of monetary policy in greater detail and provide some insight into what makes good central bank
communication and how important good central bank communication is for the success of
monetary policy.
I will cover these topics in three steps, starting with the development of central bank
communication and its significance in general. I will then outline the particular challenges in
communicating a monetary policy operating at the zero lower bound. And finally, I would like to
give an outlook on how communication can help renormalise monetary policy without causing
any market disruptions in the process.
2 The significance of communication in monetary policy
Just a few decades ago, central banks were still somewhat tight-lipped when it came to
communication - you could almost say non-transparent. Up until the early 1990s, central banks
were still shrouded in secrecy. Economist and influential monetary theorist Karl Brunner decried
central banking as an esoteric art known only to a few select elites; incidentally, in his opinion,
this esotericism was also manifest in their inherent inability to express themselves clearly.
In this vein, the warning from former Chairman of the Federal Reserve Alan Greenspan is almost
legendary: "If I seem unduly clear to you, you must have misunderstood what I said." And it was
not without reason that a book about the Federal Reserve, which topped US bestseller lists 30
years ago, was titled Secrets of the Temple.
The example of the Fed also vividly illustrates how the communication of monetary policy has
been in constant flux. Before 1994, the Federal Open Market Committee (FOMC) provided no
information on the federal funds target rate - the Fed's key interest rate. From 1994 onwards,
statements were published for each change in the target rate.
From the end of 1999, the FOMC issued a statement after every meeting, which also revealed
voting results from 2002 onwards. From 2003, the statements also contained explicit information,
or forward guidance, on the likely course of inflation.
Since 2007, the FOMC has published individual projections for its members' growth,
unemployment, inflation and interest rates four times per year. And, in 2011, a press conference
was held for the first time following an FOMC meeting; this now also takes place four times each
year.
The aim of more intensive central bank communication is to ensure a greater degree of
transparency.
First, this allows central banks to be more accountable to the public. An independent central
banks is not a state within a state and, in a democracy, it needs to explain its monetary policy. By
explaining its decisions in an understandable way, it strengthens public confidence in its ability to
fulfil its task of ensuring price stability. This trust is the most valuable asset that a central bank
has.
Second, communication can also make monetary policy. If people are economically active -
whether as an entrepreneur, employee, consumer or however - they act in a forward-looking
way. They form expectations and can influence central banks via communication. Or, as
American economist Michael Woodford put it:
"Because the key decision-makers in an economy are forward-looking, central banks affect the
economy as much through their influence on expectations as through any direct, mechanical
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effects of central bank trading in the market for overnight cash."
In this context, the impact of monetary policy relies even less on short-term money market rates
and much more on expectations regarding the future course of key interest rates and, above all,
long-term interest rates. The entrepreneurs and banks among you will be able to confirm that
decisions regarding savings and investments do not depend on three-month money market
rates, but on five-year or ten-year interest rates. However, monetary policy normally only affects
them indirectly.
So, communication serves to steer expectations, and the better expectations are steered in line
with the monetary policy mandate, the better the central bank will stabilise aggregate demand
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and therefore price developments, too.
But how do central banks steer monetary policy expectations today? Announcing an inflation
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target plays a key role, as this leads to stability gains. It helps to anchor economic agents'
inflation expectations, which pays off in the form lower inflation volatility, amongst other things. In
this respect, it is no coincidence that the expansion of central banks' communication was
accompanied by the emergence of an inflation targeting strategy.
Even before the introduction of the euro, the ECB Governing Council had already published and
then refined a quantitative definition of price stability. However, the communication activities of
the ECB and the national central banks in the euro area went above and beyond that from the
start.
Alongside the arguments of accountability and steering expectations, the fact that the ECB, as a
new institution, did not yet have a reputation in monetary policy also played a role.
Understandable communication was used as a way of allaying any doubts regarding the
Eurosystem's commitment to stability.
Through the aforementioned press conference, the ECB has a means of communication at its
disposal that provides the opportunity to explain monetary policy decisions in a timely and
comprehensive manner.
The introductory statements are not designed to provide a comprehensive view of the range of
opinions held by the members of the ECB's Governing Council. For this purpose, the Governing
Council has, since 2015, published what it calls "accounts" - detailed written summaries of its
monetary policy meetings. These also show the range of arguments put forward.
Certain other central banks also publish the minutes of their meetings, naming who voted for
what; however, the ECB Governing Council has avoided doing this from the outset, for good
reason. This is intended to prevent the decisions made by members of the Governing Council
being judged from a national perspective in their home countries and thus to ward off the risk of
monetary policy becoming politicised.
As it happens, the Bundesbank set great store by communication with the public even at a fairly
early stage, back in the days of the Deutsche Mark. One reason for this was its marked
independence, which, as I already mentioned, compels it to be accountable. At the same time,
however, the Bundesbank was quick to recognise how much the success of a stability-oriented
monetary policy hinges on a well-informed public understanding the monetary policy strategy and
appreciating the value of a stable currency.
Had the German public been less appreciative of its stable currency, it would have been harder
for the Bundesbank to implement its policy, especially as it was not always welcomed by all.
Thus, central bank communication in the days of the Deutsche Mark was not so much aimed at
steering expectations. This would have put the Bundesbank far ahead of its time; after all, the
importance of steering expectations as a monetary policy strategy was only recognised in the
mid-1990s. On the contrary: until well into the 1990s, central bankers did not shy away from
springing a surprise interest rate decision on the markets now and then.
Nowadays, preparations for monetary policy decisions are communicated so far in advance that
often the decision itself barely comes as a surprise.
Good central bank communication is also characterised by its emphasis on the state
contingency of monetary policy decisions - in other words, it clarifies that the monetary policy
stance is contingent on the economic setting, and specifies how.
The communication should explain and convey, as clearly and precisely as possible, the
objective and how it will react to any deviations from that objective. Put simply, it should convey
monetary policy's reaction function, so as to avoid unnecessary uncertainty.
This should give economic participants a better understanding of how monetary policy will
respond to new information. Thus, they can adjust their expectations about interest rates and
inflation of their own accord, and hence their response to new information, such as an
unexpected oil price hike. And because they do this, the central bank itself does not have to react
as much to the changed economic setting.
But what exactly does good central bank communication look like? How extensive and detailed
does it have to be?
It goes without saying that more communication is not necessarily better communication.
Complete transparency could also cause confusion more than it helps to shed light on things,
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simply because of the sheer amount of information.
Nonetheless, central banks should communicate as precisely as possible, because if their
signals are not clear enough, the result can be unwanted volatility in the markets, which can also
spread to developments in the real economy.
Precise communication is especially important in times of great uncertainty, for example if, in
response to a crisis, unconventional measures are introduced, used and finally terminated. By
having a broad communication approach which uses various channels, the central bank can also
prevent specific means of communication, such as the press conference, from receiving too
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much attention.
The press conference, in particular, shows that the financial markets react very sensitively to
central bank communication. At the same time, however, monetary policymakers also keep a
close eye on financial market indicators as key factors in the monetary policy transmission
process. This mutual dependence between monetary policy and the financial markets can cause
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a problem.
This problem has already been vividly described by Nobel Prize winner Paul Samuelson, who
once compared monetary policy to a monkey seeing its reflection in the mirror for the first time:
the monkey thinks that by looking at that other monkey it is getting new information, when really it
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is just looking at its own reflection.
When the financial markets largely reflect central bank communication, the informative value of
market signals is limited - and this increases the risk of incorrect monetary policy decisions if a
blind eye is turned to these interdependencies.
The BIS's economic adviser, Hyun Song Shin, has also addressed the interplay between
financial markets and monetary policy communication, and rightly points out that - despite the
undisputed importance of the financial markets for monetary policy - the central banks should
not end up like a rabbit caught in headlights.
If central banks use communication as a monetary policy instrument, they cannot shy away from
giving the necessary guidance simply because they fear a counter-reaction from the markets.
Otherwise, communication could become an infinite loop, he noted. Mr Shin's warning was this:
"The more the central bank whispers in order not to upset markets, the more market participants
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lean in to hear better."
3 Monetary policy communication at the zero lower bound
Reaching the effective zero lower bound on interest rates presents monetary policymakers with
particular communication challenges. Since this situation is very exceptional, it is harder than
usual for economic players to predict how the central bank will act. The central bank therefore
has to explain its monetary policy reaction function even more clearly.
Since July 2013, before the effective zero lower bound was even reached, the ECB Governing
Council has been issuing forward guidance to provide information on the future path of key
interest rates. It communicated that it "expects the key ECB interest rates to remain at present or
lower levels for an extended period of time". In actual fact, the key interest rates were
subsequently lowered in multiple small increments.
Using forward guidance, the central banks did more than just make it easier to understand their
decisions. It was also possible to generate additional downward pressure on the long-term
interest rates at the zero lower bound. Forward guidance is by no means limited to information
about the future path of key interest rates, as I will explain. Rather, it encompasses all information
about future monetary policy decisions.
Forward guidance was new to the Eurosystem, but a number of other central banks had already
been using it for some time as part of their standard monetary policy toolkit. New Zealand's
central bank has been publishing projections of future interest rate developments for two
decades, while Norway and Sweden were the pioneers in Europe.
Thus, forward guidance should not be mistaken for an instrument that can only be used in times
of crisis - even though it only became known to a broader public after the 2007-08 crisis. And
there is a certain disparity between forward guidance and the state contingency of monetary
policy decisions, which I mentioned just before.
The literature is keen to make a distinction between Delphic and Odyssean forward guidance.
The first alludes to the Oracle of Delphi, who made predictions but no promises. The second
refers to Odysseus, who had himself tied to the mast of his ship and plugged his sailors' ears
with wax so they would not succumb to the lure of the Sirens' song.
A central bank that uses Odyssean forward guidance would not let itself stray from its path, once
announced, under any circumstances. It follows its announcement without fail - hence why this
is also referred to as "unconditional" forward guidance.
The forward guidance issued by the ECB Governing Council, on the other hand, was always
conditional. The announcement was based on the assessment of the overall subdued outlook for
inflation extending into the medium term. If inflation had picked up faster than expected, the
Eurosystem would have been able to deviate from its announced path, albeit with certain efforts
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to justify this. Anything else would have been incompatible with the ECB's mandate.
To further loosen monetary policy despite the limited scope for action at the zero lower bound,
the central banks ultimately opted for unconventional measures; an extensive asset purchase
programme was adopted in the Eurosystem.
When the asset purchases began, the forward guidance was expanded to include a pledge that
the net purchases would continue until a certain point in time or beyond, if necessary. In any
case, they were to continue "until the Governing Council sees a sustained adjustment in the path
of inflation consistent with its inflation aim".
In due course, a statement was added to the forward guidance which raised the prospect that
the Governing Council would increase the size and/or duration of the programme if the outlook
became less favourable.
This sentence is referred to as "easing bias": by only stating that it could further loosen the reins
if need be, it underlined the expansionary monetary policy stance. I alluded to the dropping of this
sentence in March 2018 at the start of my speech, when I said that central bank communication
can also send a message when something is not said, or no longer mentioned.
Regardless of what one may think of the purchase programme - and you know that I take a
critical view of government bond purchases in the context of monetary union, especially - it is
safe to assume that the forward guidance reinforced the expansionary effect of the purchase
programme. However, expert estimates of the exact scale on which this occurred vary widely.
4 Communicating the normalisation process
To sum up, central banks' communication, especially around the effective zero lower bound,
explains not only their monetary policy but also a considerable number of separate monetary
policy stimuli.
In the last part of my speech, I would like to give an outlook on how communication can help
renormalise monetary policy without causing any market disruptions in the process.
According to the latest ECB staff projections, the euro area inflation rate will rise to around 1.7%
by 2020 - in other words, a rate that is, on the whole, compatible with our definition of price
stability. "Below, but close to, 2% in the medium term" is the objective the ECB Governing
Council set itself. It does not, therefore, come as a surprise that financial market participants
have been expecting for some time now that net asset purchases will end before 2018 is out; as
previously announced, the purchases will continue until at least September.
An end to the net purchases would represent only the beginning of monetary policy
normalisation, which will take some time. It is precisely for this reason that it is so important not
to put it off for much longer. In addition, normalising monetary policy would give policymakers
leeway again to respond to any economic slumps in the future - because the current upswing
won't last forever.
Some observers have already interpreted the latest economic slowdown as a sign that an end to
the upswing is imminent. But I think this is an exaggeration.
Following extremely high growth last year, which saw euro area growth exceed potential growth
for a number of quarters, the slowdown at the start of this year should not be understood as a
turning point in economic activity but as a dent in an upward trend. And it should be seen as
such, in particular, given the impact of certain one-off effects such as the flu outbreak, which
probably drove up sickness-related absences among your employees too.
Meanwhile, cause for concern is warranted with regard to the protectionist tendencies which can
currently be observed worldwide. These tendencies really do pose an economic risk - and yes,
ultimately also a risk to growth and welfare. It is therefore all the more important that the current
trade dispute does not escalate into a full-blown trade war.
Forward guidance is also proving useful with respect to communicating the approaching end of
the asset purchases.
Very helpful in this context are the Fed's experiences with the process of normalisation. The
comparatively vague announcement of a potential step-down of its asset purchases in May 2015
caused strong reactions in the financial markets, in the context of which the term "taper tantrum"
was coined. The expression is a combination of the term "temper tantrum", often used when
referring to ill-tempered children, and the word "tapering", which describes the process of slowly
phasing something out.
The taper tantrum highlighted that it is crucial for central banks to prepare their exit from
nonstandard monetary policy measures well in terms of communication. Just over a year later, the
Fed provided a good example of how this is done by publishing its Policy Normalization
Principles, based on which all decisions have been made since. This shows how the balancing
act between providing rough guidelines while maintaining a sufficient degree of flexibility for
monetary policy can be successful even in practice.
On the one hand, the ECB Governing Council's forward guidance contains an announcement
that the principal payments from maturing securities will be reinvested "for an extended period of
time, and in any case for as long as necessary" after the end of the net asset purchases. So,
when a security matures, the Eurosystem reinvests the principal amount in another security
upon repayment.
In simplified terms, by ending net purchases, the Eurosystem is refraining from keeping the
monetary policy to the floor, but it is not taking its foot off the accelerator either for the time being.
On the other hand, the ECB Governing Council has stated its expectation that key interest rates
will remain at their present levels "for aor n extended period of time, and well past the horizon" of
the net purchases.
In other words, not only is the Eurosystem keeping its foot on the accelerator, it has also
promised not to put on the brakes on interest rates right away.
When the normalisation process is initiated, the economic state of the euro area will presumably
be considerably ahead of the state in which the United States found itself when it started
tapering. The first interest rate increase could therefore happen much sooner after net
purchases end than was the case in the United States, where more than a year passed between
the end of the asset purchases and the first interest rate hike.
Market participants are expecting the first interest rate rise around the middle of 2019, which is
not wholly unrealistic in my opinion. At the same time, the wording "for an extended period of
time, and well past the horizon" of net asset purchases is relatively vague and raises the
question of if and when the exact point in time should be specified.
Putting an end to the net purchases eliminates the timing element of forward guidance in a way,
as a date has thus far only been named for the purchase programme. In addition, the link
between the end of the net purchases and a sustainable correction of inflation consistent with the
inflation aim is severed. However, the interest rate path and the point at which reinvestment is to
come to an end will evidently depend on prospective inflation developments.
Moreover, the Eurosystem's forward guidance has thus far not focused explicitly on the
sequence of the first interest rate hike and the end of reinvestment. If we take the Fed's
sequencing as a blueprint, the interest rate hike comes first. In any case, that is the order most
financial market participants are expecting, and the ECB Governing Council has not considered it
necessary to correct this expectation until now. At the same time, the Governing Council has not
committed itself either.
There are, consequently, several options for the Eurosystem to adjust its forward guidance after
the net purchases have been discontinued. The following trade-off should be borne in mind here.
The more comprehensively any future steps are outlined, the more accurately market
expectations can be steered. As a result, uncertainty decreases as market participants' room for
interpretation regarding future interest rates diminishes.
However, this also increases the risk of the Eurosystem having to deviate from the
communicated path at a later date due to new information and a revised assessment regarding
future inflation developments.
Here we have it again. In the words of Harry Truman: "On the one hand ... on the other hand."
Furthermore, the ECB Governing Council is faced with the question of how it can provide the
markets with greater clarity on the trajectory of interest rate increases during the normalisation
process and beyond.
In my view, publishing detailed interest rate paths, as some central banks already do, including
those of Sweden and Norway or the United States, would be taking things too far. While Sweden
and Norway create what are known as fan charts on changes in key interest rates, the Fed
publishes what it calls dot plots illustrating the interest rate level the individual FOMC members
deem realistic for the next few years and in the long term.
If the forecasting uncertainty is high, publishing point forecasts on the interest rate path could
prove more confusing than beneficial - even scientific studies are unable to paint a clear picture.
5 Outlook
Ladies and gentlemen
In my speech, I have highlighted the importance of central bank communication as an instrument
of monetary policy. Communication is vital not only to make a central bank more transparent, but
also, and above all, to steer expectations.
The Eurosystem's forward guidance meant that the introduction and implementation of
nonstandard policy measures could be flanked by communication. Forward guidance will also prove
valuable when phasing out non-standard monetary policy measures, without the ECB Governing
Council having its hands tied for the future.
Over the next few weeks and months, the Governing Council will have to address the issue of
how to prepare a communication strategy for the normalisation process.
The times when central banks could allow themselves to be shrouded in secrecy are long gone.
Thank you for your attention. I look forward to the discussion.
1
M Woodford (2005), Central-bank communication and policy effectiveness, presentation at the Federal Reserve
Bank of Kansas City Symposium, Jackson Hole.
2
See R Clarida, J Galí and M Gertler (1999), The science of monetary policy: a new Keynesian perspective,
Journal of Economic Literature 37, No 4, pp 4-1707.
3
See, for example, C J Erceg and A T Levin (2003), Imperfect credibility and inflation persistence, Journal of
Monetary Economics 50, pp 915-944.
4
O Issing (2004), Kommunikation, Transparenz, Rechenschaft - Geldpolitik im 21. Jahrhundert, Thünen lecture
at the annual conference of the Verein für Socialpolitik in Dresden.
5
C A Sims (2005), Rational inattention: a research agenda, Deutsche Bundesbank Discussion Paper 34/2005.
6
S Morris und H S Shin (2018), Central bank forward guidance and the signal value of market prices, BIS Working
Paper 692.
7
P Samuelson (1994), Panel remarks, Federal Reserve Bank of Boston conference, Conference Series 38,
Jeffrey C Fuhrer (ed), Goals, guidelines and constraints facing monetary policymakers.
H S Shin (2017), Can central banks talk too much? Speech at the ECB Conference "Communication challenges
for policy effectiveness, accountability and reputation", Frankfurt, 14 November 2017.
9
B Coeuré (2017), Central bank communication in a low interest rate environment, Speech at Bruegel, Brussels,
31 March 2017.