Luis de Guindos: Communication, expectations and monetary
policy
Intervention by Mr Luis de Guindos, Vice-President of the European Central Bank, at the ECB
policy panel of the Annual Congress of the European Economic Association, Manchester, 27
August 2019.
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Introduction
Ladies and Gentlemen,
Every year, the ECB organises a policy panel at the Annual Congress of the European Economic
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Association.
The intention of these panels is to combine the results of research and the views of policy
makers to advance our thinking on a topic of great policy relevance. This year, it has been
straightforward to decide on such a topic. Communication and expectations are central to the
conduct of monetary policy, and there is a substantial body of research that allows us to have an
informed discussion on the topic. It is therefore a great pleasure for me to speak at this year's
policy panel.
Central banks communicate with many different groups of economic actors. Let me focus my
remarks on two such groups, both of which are essential to the conduct of monetary policy,
namely participants in financial markets on the one hand, and the general public on the other
hand.
The central role of financial market expectations in the conduct of monetary policy
There is a tight two-way relationship between central banks and financial markets. Extensive
research has dealt with the flow of information from central banks to financial markets, and has
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shown that central bank communication exerts strong effects on financial markets.
For instance, as central banks have become transparent about their objectives and their reaction
functions, the inflation expectations that are priced into financial assets have become better
anchored. They have become less volatile and broadly aligned with the central banks' inflation
aims. Beyond this, markets also react strongly to the communication of the central bank's
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assessment of the current conjunctural situation and the economic outlook.
At the same time, the influence also goes in the other direction: financial markets send signals to
the central bank, which constitute a central input to decision-making. It is important for us to get
the market view about where the economy stands, and where it is heading. This helps us
crosschecking our own views, and it provides us with a benchmark against which we can
communicate our own assessment. For instance, our projections are based on market
expectations about the future path of short-term interest rates, oil and non-oil commodity prices
and stock market prices - effectively, we are therefore telling the markets where, in our view, the
economy is heading if their expectations were to materialise.
To put it in other words, central bank communication has to be two-way. The central bank talks
and listens to financial markets at the same time. There are two points in this relationship which I
want to highlight.
First, by influencing asset prices and expectations of financial market participants, the central
bank affects the very signals which it wants to use as input to its policy making. This has
become known as the "echo chamber effect". As Hyun Shin from the BIS has put it, "the louder
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the central bank talks, the more likely it is to hear its own echo."
This is particularly prominent in times when the central bank gives strong forward guidance. ECB
research has shown that in such circumstances, market expectations become "cemented", i.e.
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they do no longer respond to news about the macro economy.
This is something we need to keep in mind when designing our communication strategy and
when reading the signals from financial markets - the more forward guidance we give, the less
informative are market signals for gauging the state and the expected evolution of the economy.
A second point is that even if central bank transparency and communication has helped
anchoring market-based inflation expectations, they do remain rather volatile. The volatility itself
is a signal that is useful for us to understand. However, even if markets are volatile, central bank
policy cannot be volatile. Hence, we need to look through some of this volatility to get a feeling for
the underlying pricing that would result in the absence of short-term market moves that are likely
to revert quickly.
The echo chamber effect and the inherent noisiness of market signals are reasons why we need
to take the expectations that are priced in financial markets with a pinch of salt. This means that
we need to also rely on other sources of information to ensure that we conduct a robust
monetary policy. The incoming macroeconomic data are one such source. As we keep
stressing, our monetary policy is data dependent, not market dependent: indications from market
expectations cannot replace our policy judgement. Another way of robustifying our analysis is to
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look for expectations beyond those expressed in financial market prices.
The importance of communication with the general public
This brings me to the second group of actors I want to mention, the general public. Central bank
communication with the general public has only more recently gained the attention of academic
research. Also here, we need to think of the interaction as a two-way street.
On the one hand, central banks have a lot to learn from consumers. For instance, consumers
form inflation expectations that can tell us to what extent the central bank's inflation aim is
perceived to be credible. Variations in consumer inflation expectations are also an indicator that
central banks monitor, because these affect household decision-making and do therefore shape
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economic outcomes.
While we have ample data available on expectations formed in financial markets, we know much
less about those of consumers. To bridge this gap, we have just recently started to develop a
new consumer expectations survey. This project is still in its early stages (we will soon
implement a pilot survey), but it will provide us with a tool to collect information at regular intervals
on household expectations and decisions, covering a broad range of topics including household
income and finances, consumption, inflation, labour and housing markets. This will allow
deepening our understanding of consumer behaviour in the euro area and give us up-to-date
information on expectations that can feed into our policy analysis.
On the other hand, central banks do not only want to learn from the general public, they also
actively reach out to it, making this a two-way interaction. They do so for several reasons. First,
to manage expectations about economic outcomes - inflation expectations, but also
expectations about financial stability and the safety of individual banks. Second, independent
central banks need to make sure they are accountable to the public.
For both objectives, first-order importance should be given to making sure the general public
understands the mandate of the central bank, and trusts its commitment and ability to deliver on
its mandate. There is ample evidence that this matters.
ECB research finds that general trust in the ECB has an impact on consumers' inflation
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expectations, in two ways.
First, it lowers their uncertainty about future price developments. Second, those who trust are
less likely to have inflation expectations that are far from the ECB's inflation objective. In other
words, trust in the ECB helps anchoring inflation expectations around the ECB's inflation
objective, as agents are more likely to view deviations of inflation from the target as temporary.
And it matters how the central bank drafts its communications - research has shown that
relatively simple, but targeted messages, are particularly effective in shaping consumers' inflation
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expectations.
So it is important to increase awareness about the central bank mandate and to enhance trust in
the central bank. Just as an aside - the ECB's task here is particularly challenging, as we need
to communicate in 24 different languages. In any case, we have stepped up our efforts along
these lines in several dimensions. Let me highlight three of them:
First, we have developed educational material about the ECB and its policies that is made
available on our website - for the young generation in particular, but also more generally: there
are educational games and videos, and we have published a large number of "explainers" where
we give answers to frequently asked questions. Just to give one example - with our Euro@20
game, we reached 1.6million people.
Second, we are now much more present in the social media. This is an important channel
whereby central banks can reach out a relatively broader audience directly, without
intermediaries, and interact with the public, for instance through our Q&A sessions on Twitter.
Third, we are also working to make our regular policy publications more accessible to the general
public. Our most recent Financial Stability Review, with a streamlined structure and clear focus
on core messages, is presented on the ECB's website in a way that makes the content more
easily understood, for instance by using visuals. Our efforts are already bearing fruit - with a
significant increase in its readership.
Conclusion
Let me conclude by reiterating the central role of expectations in the conduct of monetary policy.
We are well aware that our communication influences the very expectations that we want to use
as input into our decision-making. We do therefore need to ensure that we base our decisions on
a multitude of information, covering not only financial markets and experts, but also the general
public. At the ECB, we are enhancing our toolkit for the communication with the general public in
two ways - both by collecting more information about consumers, and by targeting some of our
communication efforts more directly at the general public. I am confident that this investment will
pay off and help us achieving three objectives at the same time - being a trusted institution, being
accountable to the public, and maintaining price stability.
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Prepared by M. Ehrmann (DG-R/MPR), with input and comments from Dimitris Georgarakos, Gabriel Glöckler,
Jean-Francois Jamet, Marek Jarocinski, Eric Persson, Hanni Schölermann and Stefania Secola.
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Blinder, A., M. Ehrmann, M. Fratzscher, J. de Haan, and D.-J. Jansen (2008), Central Bank Communication and
Monetary Policy: A Survey of Theory and Evidence. Journal of Economic Literature 46(4), 910-945.
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See, inter alia, Jarocinski, M. and P. Karadi (2019). Deconstructing Monetary Policy Shocks: The Role of
Information Shocks. Forthcoming, American Economic Journal: Macroeconomics.
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Shin, H.S. (2017). Can Central Banks Talk too Much? Speech at the ECB conference on "Communications
Challenges for Policy Effectiveness, Accountability and Reputation".
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Ehrmann, M. G. Gaballo, P. Hoffmann and G. Strasser (2019). Can More Public Information Raise Uncertainty?
The International Evidence on Forward Guidance. ECB Working Paper No. 2263.
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See also Coeuré, B. (2019). Inflation Expectations and the Conduct of Monetary Policy. Speech at an event
organised by the SAFE Policy Center.
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Duca, I., Kenny, G. and Reuter, A. (2017). Inflation Expectation, Consumption and the Lower Bound: Micro
Evidence from a Large Euro Area Survey. ECB Working Paper No. 2196.
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Christelis, D., D. Georgarakos, T. Jappelli and M. van Rooij (2019). Trust in the Central Bank and Inflation
Expectations. Forthcoming, International Journal of Central Banking.
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Coibion, O., Y. Gorodnichenko and M. Weber (2019). Monetary Policy Communications and their Effects on
Household Inflation Expectations. NBER Working Paper No. 25482.