Peter Praet: Current issues and challenges for central bank
communication
Speech by Mr Peter Praet, Member of the Executive Board of the European Central Bank, at
the conference "The ECB and Its Watchers XV", Frankfurt am Main, 12 March 2014.
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Summary
Communication is always key for effective monetary policy-making, and the benefits of good
communication are greatly increased in difficult times, says ECB Board member Peter Praet.
Speaking at a conference of ECB watchers at Frankfurt he emphasises that central banks
have been communicating more intensely during the crisis and by steering expectation more
firmly their communication have had a stabilising effect. "We communicate what we are
trying to achieve, and how we go about achieving it", Mr Praet says. Notably, forward
guidance has emerged as a useful complement to existing tools, he adds.
The introduction of Outright Monetary Transactions is according to Mr Praet an example of
how communication added to the effectiveness of monetary policy tools. The ECB reaffirmed
its commitment to the price stability mandate, as the pricing-in of unwarranted denomination
scenarios could be a potential serious obstacle to fulfilling the mandate. He adds, "The OMT
communication - unusual as it was in substance, for the ECB and probably for the entire
community of central banks - was in fact strictly coherent with our general communication
approach. It was a well-articulated frame of reference for our actions."
Until now the ECB has resisted publishing accounts of the Governing Council meetings,
Mr Praet states. One reason was according to him, that offering even more information on
the ECB's policy deliberations, in addition to what was already being provided, would come
at the expense of clarity. On the other hand, publishing an account of the policy deliberations
has now become "best practice" in the central banking community. Moreover, circumstances
have changed, economic uncertainty has increased and the tools used now include
nonstandard measures. He highlighted: "It is important for us to provide the public with a fuller
picture of the internal debate: we need to explain ourselves better." To avoid a "cacophony
problem", with many voices tending to obscure the message, Mr Praet says he would favour
to convey the content of the debate and the balance of views of Governing Council
members.
Mr Praet concludes by explaining that the value of clarity in central bank communication is
particularly evident in a financial crisis. He emphasises, "But communication - no matter how
clear - only works if the communicator is credible. The ECB has a track record of following
up words with deeds, and we intend to maintain it."
* * *
Ladies and Gentlemen1,
The last ''ECB and its Watchers'' conference took place in June 2012. On that occasion I
talked about heterogeneity across euro area countries, which was indeed a burning issue at
that time, when fractures were running along national borders within the euro area and the
integrity of the euro area itself was threatened. Today, almost two years on, the situation has
improved distinctly. Markets are slowly but consistently re-integrating. Production and
incomes are growing again and growth is spreading visibly to the most stressed parts of our
Union. And our Union has expanded in the meantime, a sign that the euro project remains an
anchor for the future of many Europeans once on the outskirts of the Continent.
But the necessary institutional transition - which is re-shaping and reinforcing the
architecture of monetary union - is still proceeding. The central bank has been
accomplishing its objective in a weak institutional environment, which did not facilitate its
task. The monetary union is composed of 18 independent states, with important internal
imbalances and with different historical backgrounds which shape their diverse policy
priorities. For some, a central bank managing the aftermath of the great contraction is doing
too little. For other, we are too bold and experimental. Our policy aim is clearly price stability
for the euro area as a whole. Several times over the past years we have been confronted
with economic and financial developments that had the potential, if not addressed forcefully,
to compromise price stability for the euro area as a whole. We had to act, to take decisions,
and to communicate these decisions to the public in a clear and coherent manner. In doing
so we were not alone, as several central banks have used communication more intensively
as an instrument of crisis control.
Monetary policy communication is never easy: one has to find the right vocabulary to
communicate to a wide audience notions and content that are not immediately intuitive but
highly relevant for the lives of many people. Monetary policy communication to a community
of peoples as diverse as the euro area's is even more challenging. This will be the subject of
my thoughts today.
Put "central bank communication" into a search engine, you get millions of results; clearly,
there is a lot of communication about how central bankers communicate these days. For
good reason.
Communication is always key for effective monetary policy-making. This is true in normal
times, but the benefits of good communication are greatly increased in difficult times. And
yet, we should also be aware of the limits of communication. It is no substitute for action. In
this, as in many other things, central banks are no different to anybody else: if warranted by
the circumstances, they need to follow up words with actions, thereby validating earlier
communication. Ultimately, this is the only way to maintain the credibility we need to achieve
our price stability mandate.
The role of central bank communication
Let me start with the role of central bank communication in general.
Successful monetary policy is not only about controlling a very short-term interest rate but
also - some would even say first and foremost - about affecting expectations of how those
rates will evolve.2 Those expectations matter because they influence the maturity spectrum
of interest rates and, through that channel, the investment and saving decisions which
determine economic growth. Therefore, by influencing expectations of future short-term
interest rates, a central bank can ensure that its monetary policy decisions are well
transmitted along the yield curve and to the broader economy3.
How do central banks steer expectations in practice? Essentially with two key elements: one
is clarity about their objective and the other is clarity about their monetary policy strategy to
achieve that objective. These two elements help to create a certain degree of transparency
about the central bank's reaction function. This transparency can be further enhanced if the
central bank lays out openly its assessment of the likely future evolution of the economy and
the risks surrounding it. Based on these ingredients the public should under normal
circumstances be able to develop over time a relatively good sense of how the central bank
will react in a given circumstance. As a result, monetary policy becomes more predictable.
This feeds into expectations about future policy rates, thereby strengthening the
effectiveness of monetary policy. Notice that the communication of a clear inflation objective
- defined in numerical terms - is a critical part of this mutual understanding between the
central bank and its public, because it provides an anchor for inflation expectations. The
importance of a credible inflation anchor cannot be emphasised enough: it contributes to
stabilising inflation dynamics and it thereby helps the central bank to achieve its inflation
objective.
In normal times, by explaining their current decisions, central banks provide sufficient
information for the public to anticipate their future decisions, taking into account the
economic outlook and its likely impact on the policy orientation. But in a financial crisis, this
may not be enough. Especially when entering uncharted policy territory - for example,
around the interest rate lower bound - it may be more difficult for the public to anticipate with
any precision future economic conditions. Also, in a financial crisis, arbitrage in financial
markets - a key mechanism that ensures a swift transmission of policy decisions throughout
the inter-temporal chain of market prices - is impaired. Market participants need capital in
order to be able to take positions that aid intertemporal transmission. But capital is scarce in
times of financial stress.
Dispersion of expectations concerning the state of the economy and the degraded efficiency
of the financial industry make the formation of longer-term interest rates an uncertain and
noisy process in crises. This puts a premium on clear communication regarding the policy
orientation. And in fact, during the crisis, central banks have been communicating more
intensively and, in some cases, have expanded their communication toolkit. Notably, forward
guidance has emerged as a useful complement to existing tools and several of the world's
major central banks have adopted it. This guidance consists of conditional communication on
the future path of policy instruments, in most cases policy rates. In times of crisis, such
guidance can help to eliminate one potential factor contributing to the overall environment of
heightened uncertainty. Moreover, it allows an alignment of the public's policy expectations
with the central bank's policy intentions.
Moving from theory to practice: Has central bank communication been an effective tool to
strengthen monetary policy during the crisis? A preliminary assessment suggests that
enhanced communication has generally served central banks well in dealing with exceptional
developments, including policy rates approaching the lower bound4. By steering expectations
more firmly, central banks' communication initiatives have had a stabilising effect, thereby
enhancing the effectiveness of monetary policy. But to be effective, communication has to be
followed by actual decisions, if and when the circumstances require them. Actions consistent
with communication are only possible if the latter is in turn consistent with the ultimate
objective and strategy of the central bank. Otherwise, the central bank either risks not
following up on the communication or, if it does follow up, it runs the risk of not meeting its
objective. In either case, hard-won credibility may be lost. This can be avoided by steering
clear of making unconditional commitments about future policy action, but by always
emphasising the conditional nature of any guidance. These conditions should be derived in a
consistent manner from the central bank's mandate and strategy.
The ECB's approach to communication
Let me now turn to the ECB's approach to communication.
Our approach starts from the premise that the central bank doesn't have superior knowledge
about how the world works. Nor are we likely to have better forecasting abilities than the
majority of observers. So what we can do is to provide an explicit, well-articulated frame of
reference for our actions. This is provided by the Governing Council's quantitative definition
of price stability, together with our stability-oriented monetary policy strategy - in short: we
communicate what we are trying to achieve, and how we go about achieving it. In practical
terms, this means that communication revolves around providing a narrative about the
economy and the outlook for price stability relative to our objective. The ECB has established
various channels through which this communication effectively reaches the whole of the euro
area. These channels include the President's press conferences, speeches by members of
the Governing Council and the different official publications, which are translated into the
official languages of the European Union. These were our main communication channels
before the crisis, and they continued to play an important role during the crisis.
However, like other central banks, we have seen that in turbulent times it was useful to
strengthen our communication. In particular, clarity of communication has been essential.
It's not to say that clarity suddenly became a new principle of communication during the
crisis. From the very beginning, we have insisted on improving the clarity - as opposed to the
mere quantity - of our communication.5 But the recent experience has shown that what
constitutes clarity under normal circumstances may not be enough in more uncertain times.
Let me highlight three instances where we found it useful to go beyond the standard clarity of
our communication in order to achieve our price stability objective.
The first time, in the summer of 2012, we were faced with a severe tail risk that did not just
pose downside risks to price stability, but actually threatened the very integrity of the euro
area. Financial markets were rife with talk about the so-called "redenomination risk". Spreads
in some stressed jurisdictions increased to levels that were difficult to justify by the
underlying fundamentals. As a result, there were clear risks to the singleness of the
monetary policy of the ECB, aggravating an already impaired transmission mechanism. In
response, we used our communication to "draw a line in the sand": we had to clarify that we
would do "whatever it takes" to deliver on our price stability mandate. This was followed up
with further decisions and communication on how concretely, in our view, the necessary
"whatever" could materialise at that particular juncture: the Outright Monetary Transactions
(OMT) programme. What did we do? Effectively, we reaffirmed our full commitment to our
price stability mandate. In addition, we said that we considered the pricing-in of unwarranted
denomination scenarios as a potential serious obstacle to fulfilling our mandate and that we
would therefore take appropriate action.
The OMT communication - unusual as it was in substance, for the ECB and probably for the
entire community of central banks - was in fact strictly coherent with our general
communication approach. It was a well-articulated frame of reference for our actions. And it
was conditional. Two elements stand out. First, the policy was specifically directed at pricing
out that particular financial premium which was compensating for risks of a break-up of
monetary union. The "whatever it takes" had its limits in this specific objective of the policy
initiative. Second, conditionality was intentionally an integral part of the design of the
programme. Any intervention by central banks which have been assigned a price stability
mandate has to take place in an environment where the solvency of counterparts is ensured.
When we lend to banks, the supervisory solvency framework applies to our counterparties.
With OMTs, this solvency framework would not have applied, because the issuer of the
securities is sovereign. So, making OMT interventions conditional on a supranational
surveillance framework that can monitor and safeguard the solvency of sovereigns - if and
when this cannot be taken for granted - was a precondition for our action.
OMTs have been effective in restoring market functioning and confidence in the integrity of
the euro area. In the period following the OMT announcement, tensions in sovereign bond
markets subsided, supported also by policies at the national level.
Before OMT there was a high dispersion in the response of lending rates to reduction in the
MRO rate. In some cases lending rates actually increased following cuts in the MRO. After
OMT, the pass through has been more homogenous across countries and lending rates
actually decreased. The response to the November cut may suggest more uniform
passthrough. Overall there is evidence that OMT has favoured a reduction in financial
fragmentation over time.
A second instance that helps to illustrate the importance of enhanced communication was in
the context of our fixed rate full allotment procedure. In May 2013 we announced that we
would extend the minimum horizon for this procedure until July 2014; in November 2013, this
was further extended for as long as necessary, and at least until July 2015. This form of
forward reassurance provided banks with some certainty about their Eurosystem funding for
as long as necessary, and therefore especially in conditions of renewed turbulence. This
reassurance has also helped ease concerns about the expiration of the two three-year
operations.
A third occasion when communication mattered was during last summer, when we were
facing pronounced volatility in the money market forward curve which threatened to
undermine our accommodative monetary policy stance. We succeeded in narrowing down
market expectations regarding the path of our instruments. In other words, we clarified our
reaction function by including forward guidance in our communication.
More precisely, on 4 July 2013 the Governing Council stated that it expected "the key ECB
interest rates to remain at present or lower levels for an extended period of time". This
qualitative statement about the likely evolution of policy interest rates was complemented by
a narrative describing the macroeconomic conditions on which this guidance was based and
which would effectively determine the length of the "extended period". More precisely, the
Governing Council explained that its expectation was based on "the overall subdued outlook
for inflation extending into the medium term, given the broad-based weakness of the
economy and subdued monetary dynamics". This conditionality of the guidance ensures full
consistency with the ECB's strategy and mandate and thus ultimately guarantees its
credibility.
Note a difference between our approach to verbal communication regarding the conditional
path of our instrument and the approach taken by other central banks. Our main motivation
was to regain control of the short-term segment of the money market in conditions in which
that market was being influenced by expectations and external factors that we considered
misaligned with our monetary policy inclinations. In other words, the stance of policy was
considered appropriate, given the outlook for price stability prevailing at the time. But the way
the stance was reflected in market prices had become subject to shocks that we wanted to
minimise. Unlike other central banks, we had not reached the lower bound and the intention
was not to inject further doses of monetary stimulus. We wanted to prevent the stimulus that
had been introduced from being removed by excess market price volatility.
But that was not all: let me stress that we have followed up words with actions. In line with
the Governing Council's forward guidance, in particular its easing bias, we cut interest rates
in November 2013 when risks to price stability materialised. In addition, last week we
confirmed and - at the same time - updated our formulation in view of the evolving outlook
for price stability. While staff forecasts gave us indications that we are gradually moving
closer to 2% inflation over the medium term, we wanted to reassert our assessment that
upside pressures to inflation will continue to be dampened by a large amount of economic
slack, and by a weakened capacity of banks to create liquidity and credit for the economy.
Because of the significant amount of unutilised capacity, our monetary policy stance will
remain as it is - with interest rates staying at the present or lower levels - even as we see
improvements in the economy. Once more, forward guidance has been the vehicle for a
more precise articulation of the Governing Council's thinking regarding the economy and the
risks that surround our objective going forward. Once more, we followed up on the pledge we
have consistently made in the past eight months since forward guidance was offered for the
first time: we will keep updating our perception of the economic horizon, and will keep the
public informed about our intentions, conditional on that outlook.
Let me illustrate how the ECB's forward guidance has helped us to regain tighter control over
market conditions and align them better with our own assessment.
First, starting from the low level reached after the May 2013 rate cut, the money market
curve shifted upward following the tapering discussions. After the announcement of forward
guidance on 4 July 2013 the money market curve flattened and shifted down, with forward
rates declining by around five basis points at maturities beyond six months. In the months
thereafter, the curve steepened and reached a new high in September 2013, before
flattening again, in particular as a consequence of the November rate cut, which has
effectively strengthened our forward guidance by following up on our communication when it
was warranted by circumstances. More recently, the forward curve has overall remained
close to the level reached after the May 2013 interest rate decision for maturities of up to two
years.
Second, there was a lasting decline in market uncertainty about the path of future short-term
interest rates. Implied densities extracted from EURIBOR options and used to gauge
expectations of the forward OIS rate show that the dispersion of short-term rate expectations
has declined from the elevated levels observed at the end of June 2013 to a level closer to
that observed in early May 2013, after the interest rate cut. Third, since the announcement of
forward guidance the sensitivity of money market forward rates to macroeconomic data
releases has declined from the high levels reached in June 2013 and become more
consistent with historical averages.
Overall, this evidence suggests that forward guidance has helped to provide greater clarity
and transparency on the monetary policy orientation, conditional on the outlook for price
stability.
Now, you may ask, what do OMTs, forward guidance and other instruments have in
common? One thing, essentially: they can only work if we are credible.
And they have served us well - thanks to the clarity of our communication, but also to the
credibility we have established over the years. In a way, our communication during the crisis
can be seen as a promise to deliver on our mandate, no matter what.
But what I said so far does not mean our communication framework is perfect - there is
always room for improvement. So looking ahead, we should ask ourselves: how we can
improve our communication?
Publication of policy deliberations
As you know, at the ECB we have been discussing publishing some kind of record or
"accounts" of our Governing Council meetings. What, and how much, of our policy
deliberations should we publish? These questions are very much part of this old debate
about our communication I mentioned before. So I think this is a good time to give you an
update of our thinking on this issue.
It is true that until now we have resisted publishing such accounts. One reason was that we
felt that offering even more information on our policy deliberations, in addition to what was
already being provided, for example, by the President's press conferences, would come at
the expense of clarity. In technical jargon, it would diminish, rather than increase, the
"signalto-noise ratio". A second reason was that we were a very young institution and still had to
establish a track record of delivering on our mandate. So we were concerned that our policy
debates could be misunderstood in ways that might damage our credibility.
So why have we changed our mind? It is true that other central banks' experience with
publishing minutes has generally been positive. In fact, publishing an account of the policy
deliberations has now become "best practice" in the central banking community.
Moreover, circumstances have changed. Economic uncertainty has increased. So, too, has
our toolbox, which now also includes various non-standard measures - which we are ready
to use to achieve our price stability mandate. Non-standard measures are complex and so
are the policy considerations that feed into the decisions on whether or not to adopt them.
Therefore, providing more information on these considerations through published accounts
adds complexity to the message. But this complexity is not "noise" but "signal", as it reflects
changed underlying realities. In a situation of fragmentation where non-standard measures
play an important role, the analysis and considerations leading to policy decisions are by
necessity much more complex than in normal times. Furthermore, by their very nature,
unconventional measures can be, I don't hesitate to admit, controversial - both inside and
outside our institution. So it is important for us to provide the public with a fuller picture of the
internal debate: we need to explain ourselves better.
Ultimately, we strive to be accountable because, in the words of Otmar Issing, this "reflects
the conviction that in democratic society accountability is the "reverse side'" of central bank
independence".6 Having established our credibility over the years, we now have the
selfconfidence to make another step that will enhance our institution's transparency even further.
Having agreed that there is a case for the publication of accounts, we then need to ask: what
should these accounts of our policy deliberations actually contain? What's more, we need to
strike a balance between the amount of information that we disclose, and the effectiveness of
our message. How do we strike that balance?
Again, we should be guided by our principle of clarity. We want to avoid creating what Alan
Blinder calls a "cacophony problem", with many voices tending to obscure the message,
rather than elucidating it7. I would favour to convey the content of the debate and the balance
of views of Governing Council members.
Another important aspect to consider when framing our communication is the implications of
the specific euro area context. It consists of different countries and nationalities, so it is not
like the United States, the United Kingdom or Japan. We are a monetary union with
18 countries. It is crucial that the governors continue to act in a personal capacity and remain
independent in their decision-making.
To sum up, the value of clarity in central bank communication is particularly evident in a
financial crisis. But communication - no matter how clear - only works if the communicator is
credible. The ECB has a track record of following up words with deeds, and we intend to
maintain it.
What will remain of the communication initiatives taken during the crisis? Will they be part of
our future communication toolkit? Perhaps forward guidance in this exact form will not be
part of our toolkit as the type of communication we have adopted in normal times should be
sufficiently clear. In contrast, any steps taken regarding the publication of accounts might
well be viewed as being a permanent change to our communication framework. By providing
additional clarity on our reaction function, this publication could help make our
communication strategy more robust. The information provided will be adjusted to the
information needs of the public over time, as the nature and complexity of the Governing
Council deliberations reflect changing circumstances. Thus, with published accounts there
may be less need for forward guidance in the future.
Thank you for your attention.