Peter Praet: Communicating the complexity of unconventional
monetary policy in EMU
Speech by Mr Peter Praet, Member of the Executive Board of the European Central Bank, at the
2017 ECB Central Bank Communications Conference "Communications challenges for policy
effectiveness, accountability and reputation", Frankfurt am Main, 15 November 2017.
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Central bank communication has been fundamentally affected by the fallout from the global
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financial and economic crisis. Throughout that period, central banks succeeded in preventing a
de-anchoring of inflation expectations. To do so, they adopted a broad range of unconventional
measures, the functioning of which is very difficult to explain to the public. This applies, for
example, to the notion of negative nominal interest rates, which is hard to communicate because
it challenges the conventional wisdom that thrift and patience are virtues that deserve pecuniary
remuneration. Against this backdrop, I would like to discuss three communication challenges that
are particularly relevant to the euro area and the ECB's monetary policy.
The first challenge is to bear in mind the multi-country nature of our monetary union, which
requires communication to be tuned to the specific context of different national audiences so as
to ensure broad participation in the public debate on euro area monetary policy.
The second challenge for monetary policy communication is to take into account the increasing
complexity of monetary policy by ensuring consistency over time and clarifying the state
contingency of the policy stance. To ensure consistency over time, it is essential for the central
bank to adopt a clear organising framework, centred on the ultimate objective, for the ECB
consisting of price stability, and adhering to a state-contingent reaction function that determines
how the monetary policy stance adjusts to changing economic conditions. As the economic
environment that monetary policy faces may indeed be subject to massive swings, state
contingency may entail pronounced differences in the monetary policy stance over time. This, in
turn, requires careful explanation - in particular in circumstances that call for unconventional
measures and, hence, leave markets and the general public without empirical precedent to help
them anticipate and rationalise the central bank's actions.
The third challenge is for the communication framework to provide clarity on the use of specific
tools in a multi-instrument context, when the central bank reaction function acquires an additional
dimension. In normal times, the central bank reaction function mainly specifies the contingencies
for loosening, tightening or maintaining a given policy stance. In unconventional times, it also
needs to spell out which tool would provide the first margin of adjustment if a change in policy
stance were to appear warranted, and how the adjustment in one policy instrument would
interact with the others.
Reflecting the multi-country nature of Economic and Monetary Union
To gauge the complexity of monetary policy communication in a multi-country currency union,
just consider some of the headlines on the expanded asset purchase programme (APP) which
appeared in major newspapers in different countries, both inside and outside the euro area, in
January 2015.
Starting from the outside perspective, reports in media outlets in the United States and the United
Kingdom spanned the full spectrum, with some saying that the ECB's "bond-buying proposal
beats all expectations" and the ECB "gets it (almost) right", while others felt that the "stimulus
may be too little or too late".
Within the euro area, newspapers in some countries claimed the ECB was a "central bank going
the wrong way", as the APP would fuel inflation and "make everything more expensive". In other
countries the tone was markedly different, with the programme considered "convincing" and
conducive to an economic environment in which "there's no excuse for the recovery not to start".
In addition to this wide range of media perspectives, the crisis has had a profound impact on the
way in which the public views institutions. For instance, judging from different Eurobarometer
surveys, trust in European institutions, including the ECB, clearly declined during the crisis and
has only started to recover in recent years (see Figure 1), while remaining consistently higher
than the levels of trust enjoyed by national governments and parliaments. The fall and rise in
public trust in turn runs roughly in parallel with the performance of the economy, as reflected in,
for instance, the unemployment rate - a point that also emerges from systematic empirical
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analysis.
These levels of trust often coincide with a disconnect between, on the one hand, the way central
banks communicate their policies and, on the other hand, the public's perception and awareness
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of the goals that central banks try to achieve and the means by which they operate. As Andy
Haldane remarked earlier this year, this disconnect means that we, as central bankers, have to
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"rethink how and with whom we engage".

The level of trust in the ECB also differed greatly across countries in the years following the crisis
and the dispersion still remains above pre-crisis levels despite some recent declines (see Figure
2). Such widely differing perceptions across countries pose a challenge for central bank
communication in our monetary union.
The ECB has sought to address this challenge with what I would refer to as a "two-layered
federal structure of communication".
The first layer consists of a set of "centralised" communication channels through which the ECB
discharges its duty to explain its euro area-wide policy conduct to the public and fulfils the
accountability requirements vis-à-vis elected representatives as required by the Treaties.
These channels include: the introductory statements at the press conferences following the
Governing Council's monetary policy meetings, in which the President explains our decisions
and summarises the economic and monetary analysis on which they were based; the monetary
policy accounts, which report, with additional detail, the deliberations leading up to the Governing
Council's decisions; speeches by Governing Council Members; a panoply of publications
bringing together the economic, monetary and financial information that serves as input to the
underlying policy assessments; and our public accountability vis-à-vis the European Parliament,
in the form of our Annual Reports, the President's testimony before the Committee on Economic
and Monetary Affairs, and our replies to questions from Members of the European Parliament.
These centralised communication channels are complemented by "decentralised"
communication channels at national level where, in particular, the national central banks of the
Eurosystem play an integral role. Equipped with in-depth knowledge of their respective
economies, and - literally and figuratively - sharing a common language with their audiences,
national central banks are essential in explaining ECB policies to the broader public in their
countries. This communication with national audiences is also important given that economic
conditions may at times diverge in different parts of the euro area. The national central banks are
then well placed to correct the potential dissonance between the rationale of monetary policy
actions tailored to the conditions of the euro area as a whole and those that national audiences
may consider more appropriate for their own economies. Explaining the common monetary
policy stance in a national context is in practice a very challenging task, especially when
countries are hit by asymmetric shocks.
Reflecting the increasing complexity of monetary policy
The challenge for communication to preserve consistency, acceptance and trust across
geographies is accompanied by another, no less intricate, challenge: ensuring consistency over
time.
Central banks' monetary policy instruments have undergone a sea change over the last decade.
The policy-controlled short-term interest rates of the ECB, the US Federal Reserve, the Bank of
England and the Bank of Japan dropped from levels between 4% and 5% to essentially zero (see
Figure 3) in a relatively short space of time. Since the beginning of the crisis, these central banks'
balance sheets have grown significantly above levels that for decades had been considered
typical (see Figure 4).

Such a profound change in policy conduct requires us to carefully explain that consistency does
not mean constancy. Consistency means that we are faithful to our mandate and seek to deliver
the monetary policy stance that, given the prevailing economic conditions, maximises our
chances of attaining our objective over the policy-relevant horizon. Pursuing our mandate has
entailed pronounced shifts in the frequency of policy changes and in the nature and composition
of instruments.
What is important, however, is that these shifts are governed by a clear organising framework
which: (i) centres on the ultimate objective, price stability for the ECB; (ii) embeds a view on the
monetary policy transmission mechanism that maps policy measures with the ultimate objective;
and (iii) yields a reaction function that determines how the monetary policy stance adjusts to
changing economic conditions. This organising framework provides a way for us to manage the
difficult balancing act of responding to material changes in the outlook for price stability in a timely
manner, while ensuring that there is sufficient evidence to justify our actions.
The key economic rationale for monetary policy communication is to make this reaction function
understood by markets and the broader public. It does so not only by announcing the prevailing
policy but also by stating the reasons and detailing the assessments that led the central bank to
adopt it, thereby allowing observers to more efficiently infer patterns than would be possible
without such communication.
Moreover, in recent years, many central banks have gone a step further to make their reaction
function more transparent and concrete. Communication on the prevailing policy and the thinking
behind it has been complemented by guidance on the future policy course. In providing forward
guidance on their main policy tools, central banks have specified the time period over which they
expect or intend to preserve a certain instrument calibration and stipulated the contingencies that
would warrant a change in instrument calibration.
This innovation in the communication framework has directly served to signal consistency in
policy conduct at a time when, first, proximity to the effective lower bound on policy-controlled
short-term interest rates might have raised doubts as to the central bank's options to deliver the
requisite amount of monetary easing; and, second, the adoption of new, previously unknown,
policy tools left observers without a clear historical reference point to gauge the central bank
reaction function. Furthermore, especially in its outcome-based formulation, forward guidance
has explicitly maintained the state contingency of policy conduct and established a clear link
between the policy objective and the future evolution of policy tools - a consideration that also
formed the backdrop for the Governing Council's decision in October to reconfirm the
outcomebased element of its forward guidance on the expanded asset purchase programme, which
remains contingent on a sustained adjustment in the path of inflation.
Overall, our forward guidance framework has left a clear imprint on the market's ability to gauge
our policy intentions. One potential metric by which to measure the effectiveness of forward
guidance on key ECB interest rates is the sensitivity of forward rates to macroeconomic news. In
the presence of clear guidance on the policy rate path, forward rates which embed investors' rate
expectations should be less reactive - over short to medium-term horizons - to macroeconomic
surprises and instead be anchored by central bank communication. Observing this metric over
time, it becomes clear that the introduction of our measures - including the forward guidance on
policy rates - has been followed by a pronounced decline in the sensitivity of forward rates at the
shorter end of the term structure, where monetary policy expectations have the biggest impact,
while rates at the longer end have remained around their historical average (see Figure
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5). Moreover, the more muted responsiveness that accompanied the introduction of the policy
package in mid-2014 also went along with a pronounced flattening of the short to medium-term
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segment of the forward curve (see Figure 6).
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We have been communicating about our asset purchase programme by disclosing two
parameters: the pace of purchases per month, and a date by which the Governing Council could
end the net purchases, provided we, by that date, see a sustained adjustment in the path of
inflation consistent with our inflation aim.
This combination of date-based and outcome-based forward guidance has made it easier for
market participants to calculate the stimulus being provided each time our programme has been
(re)calibrated. The date-based element suggests the minimum amount of stimulus that the
programme could be expected to deliver. The outcome-based element - very fundamentally -
ties the programme to our inflation aim.
Have market expectations internalised the state-contingent nature of our monetary policy? And
which element has prevailed in shaping market expectations: the date-based or the
inflationcontingent element?
Market expectations for the likeliest terminal date of the APP have not coincided with the "expiry
date" communicated in the most recent programme recalibration, but have instead typically
extended beyond this expiry date. In other words: in forming their predictions about the most likely
date for purchases to end, markets have not just looked at the date-based element of our
guidance. They have also considered the outcome-based element, which allows for the
possibility of a purchase horizon extending beyond the expiry date, if that is necessary to attain a
sustained adjustment in the path of inflation. This, in turn, indicates that the state contingency of
the APP has been well understood by market participants.
Clarifying the interaction between monetary policy instruments
In normal times, central banks adapted their monetary policy stance by influencing the level of
one short-term interest rate. In unconventional times, communication has had to cope with the
new challenge of explaining the complementarities between policy tools, as non-standard
monetary policy has become multidimensional.
To ensure that their reaction function is understood, central banks have to explain how their
policies take into account these essential complementarities in the transmission of the individual
tools - although this may significantly increase the complexity of the messages they have to
convey. In this context, it is perhaps no coincidence that the complexity of the introductory
statements delivered at the ECB's press conferences, as measured by common indices of text
readability, has also increased, and started to do so just around the time when we began the
latest round of non-standard measures in mid-2014 (see Figure 7).
A multi-instrument policy toolkit is more complex because it adds a further dimension to the
central bank reaction function. It not only has to map contingencies with modifications of the
policy stance - it also needs to clarify which tool would provide the first margin of adjustment if a
change in the policy stance were to appear warranted and how the adjustment in one policy
instrument would interact with the others.
This evolution in the policy toolkit has been fully reflected in the evolution of the ECB's approach
to forward guidance in the different phases of the crisis. Forward guidance on interest rates was
first adopted in July 2013 as a means to insulate the euro area from the global financial turmoil
that had followed the so-called taper tantrum episode a few weeks earlier. This proved to be an
effective firewall. But the subdued inflation outlook, as well as other headwinds to the euro area
recovery, stemming from, for instance, subdued bank credit, required a more comprehensive
policy package. So in the summer of 2014 we launched a complex package of policy measures
that were to be adopted in a sequential and state-contingent manner as economic conditions
evolved.
Given the essential interaction between policy tools in their transmission to the economy, the
ECB accompanied the expanded asset purchase programme that it announced in January 2015
with an adjustment to the forward guidance framework, moving from a previously singular focus
on policy rates to a dual approach combining and integrating the different elements of guidance
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on policy rates and asset purchases (see Figure 8).
Communication about the intended horizon of net asset purchases and the expected future path
of policy rates has been a key component of our policy strategy. Our forward guidance on policy
rates has acted as an enabling condition for the purchases to exert their full impact. In the
absence of reassurances that policy rates would remain anchored around levels close to their
lower bound for the entire life of the net purchases, the downward impact of asset purchases on
term premia could have been partly neutralised by expectations of rate increases. At the same
time, the conditionality attached to the intended horizon and size of our net asset purchases has
reinforced the signalling power of our forward guidance on rates.
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Conclusion
Monetary policy communication faces several distinct challenges. It has to be accessible to and
useful for a variety of audiences. It has to be consistent in diverse economic circumstances. And
it has to clearly convey the central bank's reaction function, also when the latter entails a diverse
set of instruments.
To meet these challenges, the ECB's communication uses a broad range of channels to
express the Governing Council's policy intentions at euro area level and to explain it to national
audiences. It has made further efforts to make this reaction function understood by markets and
the broader public, not least by providing detailed information on the thinking underlying its
actions. And, in recent years, it has made its reaction function more transparent and concrete by
adopting an integrated forward guidance framework.
We will continue to engage with the general public and to guide market expectations as new
challenges arise. This means that we have to continue reflecting and having constructive
debates on how to shape central bank communication in the future.
normal and crisis times, The Scandinavian Journal of Economics 115(3), pp. 781-807. It is also interesting to
note that deteriorating economic and fiscal conditions in one euro area country seem to reduce the level of trust
in the EU of citizens in other countries; see Ioannou D., Jamet, J.-F. and Kleibl, J. (2015), Spillovers and
Euroscepticism, Working Paper Series, No 1815, ECB.
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In this vein, see also the evidence in Ehrmann et al. (2013), which indicates that a "higher degree of knowledge
about the ECB generates more trust in normal times and even more so during the financial crisis".
4
See the speech given by Andrew G. Haldane, Chief Economist, Bank of England entitled A Little More
Conversation, A Little Less Action at the Federal Reserve Bank of San Francisco Macroeconomics and Monetary
Policy Conference on 31 March 2017.
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See also Coenen, G., Ehrmann, M., Gaballo, G., Hoffmann, P., Nakov, A., Nardelli, S., Persson, E. and Strasser,
G. (2017), Communication of monetary policy in unconventional times, Working Paper Series, No 2080, ECB,
and the references quoted therein.
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Given the unique structure of the euro area's monetary policy transmission mechanism, anchoring the short
and intermediate segments of the yield curve around levels consistent with a very accommodative monetary
policy stance has been even more critical for the ECB than for other central banks engaging in similar policies.
For further details, see my speech at the Fixed Income Market Colloquium in Rome on 4 July 2017.
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For additional details on the rationale of this forward guidance framework, see my remarks at the MMF Monetary
and Financial Policy Conference on 2 October 2017 in London.