Stefan Ingves: Communication - what demands are made of an independent
central bank?
Speech by Mr Stefan Ingves, Governor of the Sveriges Riksbank, at the Swedish Economics
Association, Stockholm, 24 April 2007.
* * *
Introduction
I shall begin by thanking you for the invitation to the Swedish Economics Association. It has become a
recurring and pleasant task for the Governor of the Riksbank to discuss the Riksbank's activities with
this knowledgeable assembly.
Since I was last here, a year ago, quite a lot has happened in the monetary policy field. We at the
Riksbank have, for instance, implemented a number of changes to make our communication clearer.
We have replaced the earlier Inflation Report with a Monetary Policy Report. We intend that this
change of name should signal that the report now contains a description of the considerations we
have made when we have taken our interest rate decisions. Another new element is that we have now
begun to present the forecast for the repo rate that we consider will provide well-balanced monetary
policy ahead.
There is nothing strange about our methods of working changing over time. We are constantly trying to
improve and develop our methods. After all, monetary policy is also to a large extent a learning
process. In part, this is a case of gradually discovering shortcomings in our methods of working and
trying to remedy them. However it is also because we live in a changing world, where we must adapt
as demands on our operations change - demands that may come from various directions.
My theme today is that a modern, independent central bank needs to take many considerations in its
monetary policy work, not least in its communication. There are above all two aspects that we must
always take into account. The first is that we have a responsibility as an authority towards the Swedish
people and their political representatives. The second is that we must communicate and interact with
the financial markets when we implement our monetary policy.
I intend to devote the major part of my speech to illustrating some different aspects of the demands
made of us. The areas I intend to talk about are transparency, signalling and the future interest rate
path. There are no sharp dividing lines between these areas. How we regard the future interest rate
path is, for instance, part of our signalling, and the quality of our signalling in turn has significance for
how transparent we are. Transparency in itself is part of our role as a public authority. But I
nevertheless consider it worth discussing them under separate headings.
The role as authority and interaction with the market
Let me before I do so say a few more words about our role as public authority and our interaction with
the market. I intend to begin with the latter aspect. The interplay between the Riksbank and the market
is of central significance for monetary policy. It is a question of mutual dependence. For example, the
Riksbank is to supply an efficient payment system - a financial infrastructure. We also oversee the
stability of the system. Moreover, we are responsible for providing Swedish banknotes and coins.
However, at the same time we are dependent on the financial markets to implement monetary policy
measures.
The game rules for our interaction with the financial markets have changed quite a lot over the past 25
years. The most dramatic changes took place in connection with the deregulation of the credit and
foreign exchange markets that begin in the 1980s. The deregulation has contributed to more efficient
pricing which better reflects demand and supply conditions. The efficiency of the financial markets has
considerable importance for the impact of monetary policy via the transmission mechanism.
The impact of our policy also depends on how well we succeed in communicating our intentions to the
market. The more open and clear we are, the better chance we have of influencing interest rate setting
in the way we want, not just in the short term, but also over a part of the so-called yield curve. This
makes some demands of our actions.
The other aspect - that we are a public authority with responsibility towards the general public and
their elected representatives - also makes a number of demands of us. The public authority role
means that we are at the end of a delegation chain. The people have elected a parliament which has
legislated on the Riksbank's objective and appointed the General Council of the Riksbank. The
General Council in turn appoints the Executive Board with six members who are to make the monetary
policy decisions.
This type of delegation may be appropriate when political decisions risk leading to time horizons that
are too short. This problem is dealt with in monetary policy by the Riksbank having a high degree of
independence and a clear statutory task. Delegation may also be appropriate if there is a question of
technically complicated activities. Monetary policy is such an activity. There are also many other
authorities, for example, the Swedish Nuclear Power Inspectorate and the Swedish Civil Aviation
Authority, who are responsible for technical issues that have considerable importance to society. Most
people probably think that, for instance, the length of a runway at an airport or the design of the
cooling system in a nuclear power station should be determined by experts and not through political
voting.
Some of the demands made of us on the basis of our role as authority are fairly obvious. We must, for
instance, to the best of our ability try to meet the price stability target we have been allocated. We
must also be able to explain in a good way to the general public why we act in the way we do. This is
particularly important as the Riksbank has such a high degree of independence. This independence
means that it is important to be able to evaluate how we are carrying out our duties. To make it
possible to evaluate us, we must be open and clear in everything we do.
But it is perhaps not as self-evident that the responsibility of public authority makes a number of other
demands on our actions. This applies, for instance, to the forms for how we make our interest rate
decisions and how we communicate our monetary policy intentions. The latter is usually called
"signalling" in central bank language. I shall return to this.
Transparency - being open and clear
It was long common for central banks to be secretive and a little mysterious. One example, which
today may sound fairly strange, is that the Federal Reserve, the US central bank, did not begin
publishing the interest rate changes it had decided until 19941.
However, over the past fifteen years, central banks have in general become increasingly open and
clear with regard to their actions and intentions. This applies both in inflation-targeting countries like
Sweden and in countries that have not quantified a target, like the United States.
Democratic reasons for transparency...
There are several reasons for the increased openness and clarity, or transparency, as it is usually
called. The most important one is probably that the central banks have become more independent in
relation to the political system. As I observed initially, it is the general public who, via the political
system, are the central bank's ultimate principals. As the central banks became independent, it
became more important that the general public should have an insight into their operations. It was
quite simply not compatible with good democratic tradition for an authority allocated a high degree of
independence to remain closed and secretive. Increased transparency was a means of creating
legitimacy among the general public for the new system.
...and efficiency reasons
But there are not only political reasons as to why the central banks have become more open and
clear. Another explanation is that many central banks have seen greater transparency as a means of
more easily attaining their objectives and of making monetary policy more efficient. This applies in
particular in the countries that have begun applying inflation targeting. One could call this an economic
argument in favour of transparency. This is partly connected to the fact that if monetary policy is
transparent it will become easier for economic agents to know that the interest rate decisions made
are really aimed at achieving low and stable inflation. Openness and clarity can thereby contribute to
increased credibility and anchor inflation expectations around the target. This was an important reason
why the Riksbank began to publish its forecasts and other material on which decisions were based
early on in the new inflation-targeting regime. I am convinced that we would not have been able to
build up confidence in the price stability target as quickly as we did if we had not been as open as we
were regarding our work and our decisions.
The economic argument in favour of transparency is also linked to the fact that openness and clarity
are today considered an important part of the monetary policy in itself. According to economic theory,
there is a correlation between interest rates with different times to maturity. Expectations of short-term
interest rates, which the central bank governs, are important to the long-term interest rates. By
influencing expectations of short-term interest rates, a central bank can therefore also indirectly affect
interest rates with longer maturities. Greater influence over rate-setting for all maturities - the yield
curve - will raise the degree of impact of monetary policy. This is sometimes called conducting
monetary policy by "management of expectations". Monetary policy is to a large degree about
influencing expectations. And the best way to do this is to provide good information.
The most obvious way for a central bank to influence expectations of monetary policy is to present the
future path for the policy rate that the bank itself considers most reasonable. This is what the Riksbank
began doing with effect from the first Monetary Policy Report published this year. I will talk about this a
little more in a moment.
Let me take up a final argument in favour of transparency that I believe should not be underestimated.
It is that by being open and clear towards the outside world we also become better in our analysis
within the walls of the Riksbank. As transparency makes it easier to evaluate how well monetary policy
functions, it quite simply increases the incentives for us to do a good job.
The objections are not convincing
However, not everyone is agreed that transparency is a general blessing. Academic research shows
both advantages and disadvantages with transparency. A theoretical result from this research that has
received much attention is that more public information from central banks and other authorities can in
some cases be a negative element2. However, this result is based on the public information being of
low quality. If the economic agents attach greater importance to poor public information than to their
own better private information, the economy as a whole may suffer losses. However, this assumes
that the public information is much poorer than the agents' own information - an assumption that is
hardly true in practice3. A more reasonable assumption, in any case with regard to central banks and
monetary policy, is that public information is not poorer than the assessments made by private agents.
Central banks probably invest greater resources than any individual agent into studying the economy,
assessing the economic situation and making forecasts. Reasonably, central banks should also know
more about their own intentions than any other agent.
It is therefore possible to construct theoretical cases where a lower degree of transparency is
preferable to a higher degree. But on the whole the research appears to indicate quite clearly that a
high degree of transparency is something the central banks should aim at. It is easy to agree with this
conclusion. Here I think that the demands on a public authority in a democracy have great importance.
Then I believe that in practice there are limits as to how transparent a central bank can be. In some
respects it is quite simply difficult to be open and clear. This applies, for example, to how much
emphasis the central bank places on stabilising the real economy relative to stabilising inflation. In
theoretical models this is usually represented by a special parameter in the central bank's so-called
goal function. However, placing a value on this parameter which is then published would probably be
very difficult in practice. The step from theory to practice is probably too great in this case, at least for
now.
The interest rate path
An important part of the transparency concerns the central bank's communication of its monetary
policy intentions. So, how open and clear should a central bank be with regard to its own assessment
of the future interest rate path? I would like to reply "as open and clear as possible". And I believe that
we at the Riksbank work in this way today. But the road to this standpoint has been very long and
lined with various requirements and considerations.
With regard to the assumption of the future interest rate, central banks use three different approaches.
The first is that the policy rate will remain unchanged throughout the forecast period. According to the
second approach, the policy rate is instead assumed to follow market expectations. The third
approach means that the central bank works on the basis of its own forecast for the development of
5
the policy rate.4 The Riksbank has moved away from the first of the three approaches, via the
second, to now publish and build its forecasts on the basis of our own view of what we consider to be
a reasonable development in interest rates in the future.
Why did we take this step and why did we not take it before this year? Well, the easiest answer is
probably that "everything has its place". A solution that at one point in time matches the requirements
made of us will perhaps not work at all when conditions change. And the world around us is of course
anything but static. Then there is also a measure of "learning by doing" in this.
From unchanged repo rate...
Up to October 2005 our inflation forecasts were made under the assumption that the policy rate would
not change during the forecast period. The advantage of this method was that it illustrated in a simple
manner when there was reason to change the policy rate. If the forecasts showed that inflation two
years ahead would be lower than two per cent, this was a signal that the interest rate needed to be
cut. If inflation would be higher, the interest rate usually needed to be raised.
This rule was easy to understand and was therefore a good educational tool. This characteristic was
particularly important when the rule was introduced. It was a question of winning back confidence in
monetary policy and anchoring inflation expectations around the new target of two per cent. To
succeed in this it was necessary for households, companies and the financial markets to understand
the motives behind the monetary policy decisions. Here the simple rule probably played an important
role.
However, there were also considerable disadvantages. For instance, it is not a particularly realistic
scenario for the policy rate to remain unchanged a couple of years ahead. It was therefore difficult to
make forecasts that were totally coherent. The assumption also made it difficult to assess our
forecasts and to compare them with those of other forecasters.
Moreover, it gradually became clear that this rule could sometimes be an obstacle to our
communication. Too much focus was on the current interest rate decision and the inflation forecast
exactly two years ahead. On the other hand, neither the general public nor the financial markets
received any clear guidance as to how we viewed interest rate developments further ahead. As our
credibility increased, we gradually gained greater scope to conduct more flexible monetary policy. This
also led to a greater need to show that it is the entire expected sequence of events for inflation and the
real economy a few years ahead that is important to monetary policy decisions, and not merely the
levels we foresee two years ahead. And the focus should be on not only current interest rates, but also
expectations of future interest rate changes6.
...to market expectations...
We left most of these problems behind us when we changed over in October 2005 to making forecasts
based on market expectations of the future development of the policy rate. Compared with the
assumption of an unchanged repo rate, market expectations normally provide a much more realistic
forecast. This was one thing that made it easier to evaluate us.
However, an assumption that the policy rate will develop in accordance with expectations in the
financial markets has its disadvantages. This perhaps applies above all to the difficulties in
communicating the interest rate path when market agents' assessments differ substantially from those
of the Riksbank. Another problem that could lead to a lack of clarity in communication is how market
expectations of the development of the policy rate should actually be measured. It may be difficult to
estimate and adjust for different premiums - the compensation for differences between securities with
regard to the maturity, credit risk and degree of liquidity required by an investor. There are also
different ways of doing it.
...to our own interest rate path
These problems disappeared or at least were much alleviated when we chose to present our own
forecast for the interest rate path. One important reason why the new interest rate assumption was
introduced was so that it would become easier to understand the motives behind our decisions. This
creates better opportunities to evaluate monetary policy. It thereby provides good conditions for
accountability and legitimacy for an independent central bank like the Riksbank. To refer back to what
I said earlier this evening - I believe that the new system will enable us to better meet the
requirements for openness and clarity made of us in our interaction with the general public and the
financial markets.
As I mentioned earlier, it is probably difficult a central bank to be much clearer than this with regard to
what they consider to be well-balanced monetary policy. We gain an even better tool for influencing
expectations among households, companies and agents in the financial markets. This is a
precondition for monetary policy to function well.
One aspect that may not have been given so much attention is that it has become simpler for
households planning their private economy to form an impression of which direction the interest rate
will take. Previously, many people were probably forced to rely entirely on financial advisers to
understand how the Riksbank envisaged interest rate developments a couple of years ahead. Now
this information is available in our Monetary Policy Report. In general, it can be observed that many
people, particularly in the financial markets, put a lot of effort into making forecasts for the repo rate. If
we can contribute to reducing uncertainty over how we ourselves view the future, this should be
positive for everyone.
Manageable difficulties
But of course there are also some difficulties that need to be managed when a central bank presents
its own forecast of the interest rate path. As you know, the Riksbank's monetary policy decisions are
taken by an Executive Board consisting of six people. While the decisions we make concern the level
of the repo rate applying until the next monetary policy meeting, we must also agree on what we
consider to be a reasonable development for the repo rate throughout the forecast period. There may,
of course, be occasions when the members of the Executive Board have different opinions. For
instance, the members may disagree as to how quickly inflation should be returned to target after a
shock. This type of situation may be complicated. But after all, we have managed to agree earlier on
interest rate messages that have contained information on our future intentions.
Other arguments have also been put forward against publishing one's own forecast for the
development of the policy rate. One is that it could damage our credibility and make communication
with the general public and the financial markets more difficult. Let us assume that the central bank
first notifies a particular interest rate path but that new information is received afterwards, which leads
to a policy rate decision that differs from the path published earlier. According to this argument, the
deviation could be perceived as a failure by the central bank and could impair the bank's credibility7.
However, I am fairly convinced that it is the other way around - that communication will now be clearer
and more efficient. I believe that there is currently widespread understanding among households,
companies and market participants that monetary policy must be adjusted when the prevailing
conditions change. A forecast is by nature uncertain and this applies even more the further ahead it
stretches. We have also been clear on this point. Our assessment of the development of the repo rate,
as presented in the Monetary Policy Report, is a forecast. It is not a promise! When new information
changes the economic outlook, we must of course reconsider our view of how the repo rate should be
set in the future. But this is hardly a reason to refrain from being as open and clear as possible about
what we currently believe will happen. As I have said on previous occasions - it would be roughly like
the Swedish Meteorological Institute refraining from publishing five-day forecasts because conditions
might change in the meantime.
Another argument against publishing interest rate paths is linked to the way the market functions. This
means that in principle the financial market agents could stop looking for other information if they have
access to the central bank's forecasts for interest rates in the slightly longer term. How the market
views economic prospects is normally reflected in the long-term market rates. This source of
information could thus be lost and this would impair the functioning of the market.
But I find it very difficult to imagine that the market agents would stop making independent
assessments because we are now publishing our own view of interest rate developments. They know
as well as we do that we are living in an uncertain world and that the forecasts we make are constantly
being revised. They have strong reasons for continuing to look for information via other channels than
the Riksbank and for assessing this information, even when we publish our forecast of the future
interest rate path. In the long term, there are of course more factors than expected monetary policy
which are significant for interest rates. Although we have as yet only had time to present one repo rate
forecast, there has been no sign that the market has become "passive". On the contrary, it has
become clear that we and other market agents have had slightly differing views as to what would be a
reasonable future development for the repo rate. In a way, this is a good sign. It is in the nature of
things that forecasters make different forecasts, particularly in the slightly longer term. That it how it is
when one works with economic forecasting.
Our assessment is therefore that any difficulties arising from the new assumption are manageable. But
different types of interest rate assumption also make different demands on our communication. One
important aspect of what the publication of our own interest rate path means is our method of
signalling.
Signalling
Let me therefore go on to talk about the Riksbank's signalling. By this I mean, quite simply, how we
communicate our monetary policy intentions. In brief, the Riksbank's practice can be described as
follows. Between the monetary policy meetings the individual members of the Executive Board have
often held speeches on the theme of "the current situation" or similar. In these speeches we have
given our views on economic developments and sometimes also indicated, with varying degrees of
explicitness, how we consider the interest rate should be set at the next meeting. It has on these
occasions been clearly understood that the Executive Board members are expressing their own
personal opinions. One could call this a sort of "signalling by degrees". That is, when the interest rate
decision has been taken at the monetary policy meeting enough information should have already been
signalled by degrees so that economic agents are not taken by surprise. And on the whole, our
signalling policy appears to have worked quite well.
But, like many other things, the demands made of our signalling have changed over time. Things look
quite different today from when the inflation target was new and confidence in monetary policy was
low. This is partly linked to the fact that for some years we have been an independent authority, with
the demands for insight that this entails. It is also, as I have just implied, connected to the important
changes we have recently made in our communication. Moreover, there may be some potential
problems in the way we have signalled previously, although as I said it has worked fairly well.
I intend to mainly focus on the time aspect of the signalling, that is, when or how often we signal or
should do so. I would like to point out that what I say here is my own personal reflection after just over
one year as Governor of the Riksbank. It is not an expression of the general view of the Executive
Board. At present we are discussing the issues I am taking up here. And it is quite natural that we
should discuss this. Since the inflation target was introduced we have been constantly working on
refining and developing our methods of conducting monetary policy in general. There is hardly any
reason to believe that signalling should have reached its final form and it is therefore not something
that should remain outside of the general change process.
Reduced need for signalling
The changes we have made in our communication recently have significance for the need to signal.
We now publish the path of the future repo rate that we consider most reasonable in our new
Monetary Policy Reports. The reports also explain why we have chosen this particular path. These
forecasts for the repo rate will be presented three times a year. At the meetings where no Monetary
Policy Report is published we will make a qualitative assessment of whether the most recently
published path "holds good", given the new information received. We can then communicate, for
instance, that our assessment has not changed or that we now believe that the interest rate may need
to be raised or cut slightly faster than we had previously assumed. This will make our intentions
regarding future monetary policy as clear as they can be. In my opinion, this new way of working
reduces the need for signalling prior to the monetary policy meetings.
Objections of principle...
It is also possible to raise issues of principle regarding when and how one should signal. The
signalling has sometimes been a question of wanting to communicate that we have had a slightly
different view of how the interest rate should be set at the next meeting than the market has expected.
In these situations one can say that we have preferred to prepare the market by signalling a few
weeks before a monetary policy meeting rather than to risk surprising them when the decision is
announced. But it is not necessarily the case that much can be gained by "fine tuning" expectations
over the course of a few weeks. Although this system has meant that we have sometimes been able to
avoid strong reactions and indignant comments in connection with the actual interest rate decision, we
have nevertheless had roughly the same reactions when we have signalled the probable interest rate
decision a few weeks earlier. The question is then what value the signalling has had.
...not least because we are several members who must agree
Many questions regarding the signalling are connected to the fact that we are a group of persons
making interest rate decisions. The Executive Board of the Riksbank is what is usually known as an
individualistic committee8. This means, quite simply, that the members act as individuals. This applies
both when we are out speaking and when the interest rate is set. The interest rate decisions are made
through voting and the members can publicly state whether or not they share the majority view. In the
case of so-called collegial committee, there is instead an agreement that the individual members'
views are subordinate to the group's overall opinion. If there are internal differences of opinion, they
are often concealed from the outside world and once a decision has been taken, all of the members
officially support it.
The combination of making interest rate decisions in a group and signalling between the monetary
policy meetings is not entirely problem-free. If we assume, for instance, that an individual member is to
hold a speech a few weeks prior to a monetary policy meeting where he or she gives signals that the
interest rate should be changed. Regardless of whether or not the Executive Board is an individualistic
committee, I believe that sometimes there may be uncertainty as to who is actually sending the signal.
Is it merely the individual member who is describing his or her view, or is he or she expressing the
majority's opinion?
If different members were to send out different signals as to what should happen at the next meeting, it
may also cause uncertainty as to which of them one should believe in the most. This is also a problem
raised in academic research as one of the dangers of individualistic committees - the communication
risks becoming a "cacophony of voices", without any clear message9.
A decision following the correct procedure
Here a potential conflict might arise with regard to the demands made of the Riksbank as an
independent authority. The responsibility as an authority means that interest rate decisions must follow
the correct procedure. It is important that our principals - ultimately the general public - have insight
into the decision-making process. One expression for this is that minutes are taken at the monetary
policy meetings, which are then published soon afterwards. Another is that the Chairman and Vice
Chairman of the General Council have the right, according to the Sveriges Riksbank Act, to attend the
Executive Board's meetings, which they usually do10. One might say that they are monitoring, on
behalf of the general public, that everything is done properly, that the decision-making process follows
the correct procedures. This means, for instance, that interest rate decisions may not be "mortgaged"
in advance, as I described earlier.
This shows that at least in theory there are some problems in signalling prior to the monetary policy
meetings. There is a risk of confusing the market or of "tying up" both the discussion at the monetary
policy meeting and the actual interest rate decision. As the need for signalling has also declined with
the changes made in our communication, as I see it there is good reason to reconsider the forms for
signalling.
What conclusion do I reach then? Well, as I see it, it should normally be enough to give clear signals in
connection with the seven monetary policy meetings held every year. Only in exceptional cases is
there a need to signal prior to the monetary policy meetings. And this is the way it has functioned in
practice in recent years. In the cases where we nevertheless choose to signal prior to a meeting, it
should in my opinion be clear who is behind the message, for instance, the entire Executive Board.
This method of working also guarantees the principle of following correct procedures and observable
decision-making that in my opinion is required in our role as public authority.
Let me point out that what I have said should not be interpreted as advocating a transition from an
individualistic to a collegial committee, or "putting a lid on" internal differences of opinion. Of course
the individual Executive Board members should continue to be able to express their own opinions
publicly. But as I see it, this should be more a question of afterwards clarifying and explaining personal
deliberations made in connection with the monetary policy meetings. Differences of opinion within the
Executive