Communicating Monetary Policy1
Monetary policy announcements are associated with frissons of
animated speculation rippling through public discourse. Projections
are revised, and the balance of risks are re-tilted. Shadow monetary
policy committees take positions in print and in sound bytes. Curve
fitting the central bank commences - is it behind the curve? - and
accordingly, bird-like postures are conjured to characterise its angle
of repose. Markets get poised to reprice, and financial institutions
reassess interest margins. Depositors and businesses exert
conflicting pulls on public opinion. Questions rent the air on the
likelihood of rate movements, by how much, and on shifts in stance.
Underneath the multiple shocks buffeting the global economy,
the conduct of monetary policy is undergoing a silent transformation
worldwide. In the wake of the pandemic, several central banks have
undertaken strategic reviews of their policy frameworks in tacit
confirmation of this quiet revolution2. These reviews have also shed
light on the vexed issue of communicating monetary policy which is
the theme of my address.
1
Opening remarks by Michael Debabrata Patra, Deputy Governor, Reserve Bank of
India at the "High-Level Policy Conference of Central Banks in the Global South"
organised by the Reserve Bank of India as a part of commemoration of its 90th year
on November 21, 2024 at Mumbai, India. Valuable comments received from Indranil
Bhattacharya, Binod B Bhoi, G.V.Nadhanael, and Subhadhra Sankaran are gratefully
acknowledged.
2
Coined by Alan Blinder, former Vice Chairman of the Board of Governors of the US
Federal Reserve and currently Gordon S. Rentschler Memorial Professor of
Economics and Public Affairs at Princeton University, USA.
II. The Evolution of Monetary Policy Communication
The history of changes in monetary policy architecture and
implementation is best captured in the story of the evolution of the
communication of monetary policy over the years. Until the early
1990s, secrecy was the byword in the conduct of monetary policy.
Central banks used to be shrouded in mystery and they believed that
they should be. The conventional wisdom was that monetary policy
makers should say as little as possible and say it cryptically. The
personal motto of Montagu Norman, the longest serving Governor of
the Bank of England (1920-44) has been described pithily: "Never
explain, never excuse"3. Monetary policy was regarded as an esoteric
art with access to it and its proper execution confined to the initiated
elite. It was characterised by an inherent impossibility to articulate its
insights in explicit and intelligible words and sentences4. In fact, after
the Bank of England's rebirth twice in the past century - in 1992 as
an inflation targeter, and in 1997 as an independent central bank - a
member of its monetary policy committee (2003-06) remembered that
inscrutable era when "the stated objective of the Bank of England's
press officer was to keep the Bank out of the press and the press out
of the Bank."5
This monetary mystique was dispelled in February 1994 when
the US Federal Open Markets Committee (FOMC) first started
announcing its decision on the target for the federal funds rate. Yet,
it was not till August 1997 that the Fed publicly acknowledged that
monetary policy is formulated in terms of a target for the federal funds
rate and put a number to it. Even so, monetary policy communication
was characterised by 'constructive ambiguity'6 or what has been
described as 'mumbling with great incoherence'7. Alan Greenspan,
then Chair and high priest of this Fedspeak, turned the commitment
to opacity into an art form. He perfected a style of speaking regularly
while communicating little. On several occasions, he left his audience
less informed than before he spoke. There was an underlying
rationale to this opaqueness. Greenspan believed that a language of
purposeful obfuscation is much better than not responding; or saying,
"no comments"; or "I won't answer". The theoretical premise was that
the behaviour of rational economic agents, who use all available
information to anticipate the future, including the course of monetary
policy, could only be influenced through policy surprises.
Paradoxically, it was Alan Greenspan who started the move
towards greater transparency and openness in communicating
monetary policy. By the early 2000s, he was explicitly managing
expectations by stating that "the Fed would keep the Federal funds
rate low for a considerable period". This trend was also reflecting
broader societal changes. Considerations relating to democratic
accountability took precedence over constructive ambiguity. As a
public institution operating on delegated authority, the central bank
must be fully accountable to the elected representatives of the
people. In fact, transparency came to be regarded as an implied
corollary of central bank independence. The great transformation
came in the wake of the global financial crisis (GFC). With interest
rates at the so-called zero lower bound and balance sheets bloated
by unconventional ultra-accommodation, communication got
elevated to the status of a monetary policy instrument. Forward
guidance was actively used by central banks to go beyond the short-
term money market rate and directly influence longer-term rates.
Terms like 'low for longer' and 'to do what it takes' started populating
the language of central banks. Explanation, Engagement and
Education had become the three Es of communication8 when the
pandemic struck. The lessons of the GFC came in handy during the
pandemic when central banks became the first line of defence in an
environment of high uncertainty. People looked to central banks for
support as well as the reassurance that they would do all they could
to prevent loss of livelihood and restore stability in financial markets
and institutions. Monetary policy communication performed the role
of an anchor in an ocean of fear and vast unknowns.
When inflation checked in from the second half of 2021 and rose
to levels not seen since the 1970s and early 1980s, central banks
reacted albeit belatedly with large and consecutive interest rate
increases. Suddenly, the lessons of the GFC were no longer relevant
as terminal rates in this tightening phase could not be communicated
in view of the stubbornness of the inflation episode. Testifying before
the Senate Banking Committee, when Chairman Jerome Powell was
charged with 'gambling with people's lives'; he responded: "will
working people be better off if we just walk away from our jobs and
inflation rebounds?"9 Furthermore, central bank authorities began to
speak with increasing fervour and frequency on the need to remain
steadfastly anti-inflationary until targets were sighted. Forward
guidance stirred up bouts of turmoil in financial markets, and
spillovers to emerging markets. In March 2023, financial stress felled
banks in some jurisdictions, unwinding of carry trade was triggered in
August 2024 and sell offs on recession fears routed markets
worldwide in September 2024. Monetary policy communication
entered a new phase of its evolution as it encountered lower signal-
to-noise ratios and the 'cacophony problem' - too many disparate
voices that confuse rather than enlighten the public.
Today, the story of monetary policy communication has come
full circle. Following its strategic review, the Governing Council of the
European Central Bank "agreed to modernise its monetary policy
communication....to make listening a regular feature of its
communication"10. An important pillar of the US Fed's review of
monetary policy strategies, tools and communication is that the 'Fed
listens'11. It is noteworthy that the RBI has been in listening mode for
more than a decade, but more on that later. It is now recognized that
communication is a two-way street. It is not just about talking. It is
also about listening in order to learn to steer the economy. The louder
the central bank talks in these times, the more likely it is to hear its
own echo12.
This guided tour through the historical evolution of monetary
policy communication yields valuable insights: (a) the principles
underlying communication are not cast in stone - communication has
to be alive to the state of the economy, the state of the business cycle
and societal influences; (b) there are limits to transparency, and
trade-offs exist between desirability and feasibility; (c) feedback
mechanisms and performance reviews must be built into
communication so that central banks listen to the public rather than
10
ECB Strategy Review (2021), Clear, consistent and engaging: ECB monetary policy
communication in a changing world, European Central Bank Occasional Paper Series
No 274, December (Revised).
11
Board of Governors of the Federal Reserve System (2020). Fed Listens:
Perspectives from the Public. Washington: Board of Governors, June.
12
H.S. Shin (2017), Can central banks talk too much? Speech at the ECB conference
on "Communications challenges for policy effectiveness, accountability and
reputation" Frankfurt, November 14.
only speak. In the rest of my address, I will explore how the RBI's
monetary policy communication fares against these lessons.
III. How the RBI Communicates Monetary Policy
At the outset, it is fair to say that the RBI's monetary policy
communication strategy is constantly evolving as it balances the
diverse and strident demands of country-specific stakeholders with
global best practices. Furthermore, there are layers in its
communication strategy which are shaped and nuanced by when,
what, who, how and how much to communicate.
Information on the objectives, policy framework, decision
making, instruments and processes designed for the general public
is updated and put out on the RBI's website, with links to key policy
rates, statements, transcripts of press conferences and minutes of
monetary policy committee meetings. Assessments based on a text-
mining approach indicate that the degree of transparency has been
progressively enhanced, especially after the adoption of the flexible
inflation targeting (FIT) framework13. Coincident survey-based
information adjusted for biases such as backward-looking price
assessment, overall sentiments about the economy and the impact
of prices of salient items on overall perceptions shows that inflation
expectations have also become anchored, and they do track realised
inflation14. This suggests that monetary policy awareness among the
lay public is increasing.
Since the adoption of FIT in 2016, the RBI's monetary policy
communication practices have largely mirrored global best practices
in terms of publishing the analysis of evolving economic conditions,
including outlooks for growth and inflation and the associated risks,
and explaining the rationales for policy decisions, both in policy
statements and through press conferences, which is followed by the
release of the MPC minutes one fortnight after the policy
announcement. Unlike some advanced economy central banks,
however, the RBI has generally refrained from providing explicit
forward guidance on the policy rate, although it has provided both
time- and state-contingent forward guidance during the COVID-19
pandemic. During the policy tightening cycle amidst heightened
global uncertainty and overlapping shocks, the RBI was of the view
that forward guidance itself could be a source of policy uncertainty
undermining policy credibility. Accordingly, it refrained from forward
guidance in the policy tightening cycle. Nonetheless, the RBI has
emphasised on clarity in communication, while maintaining a balance
between both high and low frequency communication of monetary
policy.
In recent years, significant emphasis has also been placed on
the complementary role of engagement and education in furthering
central bank communication. Pre-policy consultations are held with
various stakeholders - analysts; economists; academics; banks;
industry bodies; and domain experts - followed by post-policy
interactions with the media while reaching out to the general public.
The article on the "State of the Economy" in the RBI Bulletin every
month seeks to provide an updated synoptic view of the economy to
the public. Speeches and interviews in various forums by Governor
and Deputy Governors seek to sensitise, engage and educate the
public about the policy decisions, their rationale and policy
challenges. At the same time, central banking research has
increasingly focussed on contemporary macroeconomic and policy
issues. For instance, the theme-based Report on Currency and
Finance (RCF) 2020-21, which dealt with the theme "Reviewing the
Monetary Policy Framework" was released before the renewal of the
inflation target for the second five-year term; the 2021-22 Report
adopted "Revive and Reconstruct" as its theme in view of the
devastating impact of the COVID-19 pandemic on the economy; the
2022-23 Report dealt with climate change issues and adopted
"Towards a Greener Cleaner India" as its theme to enrich public
policy discourse on the emerging subject; and the 2023-24 Report
focused on India's digital revolution. On the educational front, the RBI
has been conducting competitions for educational institutes,
sponsoring short period internships for students and using various
electronic and social media platforms to educate people on the role
and responsibilities of the RBI so as to build trust, and gain
confidence of the public.
The RBI's communication strategy has been appreciated in
recent years. For example, the Bank for International Settlements
(BIS) in its 2018 Annual Report noted "...the Reserve Bank of India
issues short and simplified press releases for an audience with limited
financial literacy. Establishing links with the media, such as through
background briefings, is another common tool." Moreover, empirical
evidence suggests forward guidance likely played a key role in
moderating uncertainty and supporting asset prices during the initial
waves of the COVID-19 pandemic, underscoring an important role for
monetary policy communication in guiding market expectations in
India about the monetary policy stance, including the likely path of
policy interest rates.15 For example, the RBI's decision on October 9,
2020 and the Governor's statement on forward guidance was specific
about the duration of the RBI's accommodative stance, contributing
to a decline in 10-year rates on the same day.
IV. Conclusion
While the utility of forward guidance at very low policy rates is
unambiguously proven, its efficacy at higher rates is questionable.
This is consistent with the asymmetric nature of the monetary policy
cycle - the way down has a lower bound, but the way up is technically
unconstrained by any upper bound. Under heightened uncertainty,
discretion in forward guidance has increasingly gained legitimacy
among major central banks. Empirical evidence in the Indian context
suggests that forward guidance in a policy tightening cycle loses
steam as the policy rate increases beyond a threshold.16
Summing up, the optimal level of communication remains the
gold standard for all central bankers - too much can create a "signal
extraction problem" while too little can keep the markets guessing. As
a former Fed Chairman succinctly noted "Monetary policy may be
98% talk and only 2% action but cost of sending the wrong message
can be high.17 In this regard, both the monetary policy framework and
its communication need to reflect the inherent uncertainty in
policymaking. As noted earlier, forward guidance in a tightening cycle
is constrained but admitting this through communication may undo
the intent of policy. In a similar vein, while monetary policy needs to
manage inflation expectations, micromanaging them may be
counterproductive.18 In terms of targeting the audience, central banks
are still learning how best to communicate with the wider public. It is
said that communication is the bridge between confusion and clarity.
Central banks must engage in constantly refining and upgrading this
"soft skill" to make it effective. As John Powell, the famous composer
of film scores, said "Communication works best for those who work
at it". Thank you!