Consider the most powerful tools of global central banks: interest rates, payments policy, quantitative easing. And then there’s jawboning, talking about themselves.
The Reserve Bank of Australia effectively talked Australia out of a housing bubble in 2003-4, reminding investors and financiers of what might happen and what the bank could do, without really doing it.
In a key speech on the subject last year, before she become chairman of the US Federal Reserve, Janet Yellen gave a fascinating insight into central bank thinking when she described how the bank was deploying unconventional policy.
“For the first time, the (Federal Open Market Committee) was using communication - mere words -as its primary monetary policy tool,” she said. “Until then, it was probably common to think of communication about future policy as something that supplemented the setting of the federal funds rate.”
But critically “in this case, communication was an independent and effective tool for influencing the economy”. For the Fed, jawboning is an official lever of policy.
The most graphic recent demonstration of the power of this lever was European Central Bank president Mario Draghi’s now famous line in 2012 the bank would do “whatever it takes” to fend off a European financial crisis, a commitment now widely recognised as a turning point in the European recovery, more powerful than any specific actual policy.
This last weekend Draghi delivered an extremely thorough and academically rigorous defence of this stance in a speech in Amsterdam titled “Monetary policy communication in turbulent times”, in the process calling for even more clarity and transparency in the communication of ECB policy.
It seems extraordinary to think anything but the utmost transparency from central banks – which by and large consist of unelected, independent officers – should be tolerated but in fact such transparency is a very recent phenomenon.
It’s a far cry from the stance taken by Montagu Norman, the Bank of England governor of the early 20th century, whose motto was "never explain, never excuse". That was a mission statement dear to the heart of so recent a Fed chairman as Alan Greenspan who articulated the sentiment even more elliptically in saying if you think you understood what he said, you clearly weren’t listening.
As a visiting student at Columbia University in New York in 2002, our class was privy to a presentation by a senior Fed official who elucidated what the bank saw as the pros and cons of more direct communication. There was even then no clear acceptance of the role of plain speaking.
Yet central bank communication, not just the literal words but the tone, does have powerful real economy impacts.
Back in Australia, one only has to look at the controversy which erupted when the Australian Financial Review’s highly respected and very well connected political commentator Laura Tingle reported the government had pressured the RBA over its shift to a “neutral” from an “easing” bias.
Regardless of the actual state of affairs, the essence of the story is the real economy and all its accoutrement respond to what the central bank says it will do, not just what it does. Indeed, as Yellen, her predecessor Ben Bernanke and Draghi have all argued, what a central bank says it will do is the critical factor in anchoring longer term behaviour in financial and non-financial markets.
“Significant spending decisions - expanding a business, buying a house or choosing how much to spend on consumer goods over the year - depend on expectations of income, employment, and other economic conditions over the longer term, as well as longer-term interest rates,” Yellen explained.
“The crucial insight … was that what happens to the federal funds rate today or over the six weeks until the next FOMC meeting is relatively unimportant. What is important is the public's expectation of how the FOMC will use the federal funds rate to influence economic conditions over the next few years.”
Draghi made the same point on the weekend: “central banks have realised they are more likely to fulfil their mandates if they inform the public and the markets about their strategies, assessments and policy decisions in an open, clear and timely manner”.
He acknowledged the granting of more independence to central banks called for a commensurate increase in accountability to the wider public.
Little wonder then that central bank statements now receive the closest textual scrutiny since the days of FR Leavis, the literary critic famous for his “close reading” of the text.
But Leavis was a literary theorist of the early 20th century who wrote at a time when questions of interpretation were more straightforward. He was followed by a period of intense scepticism about how to actually pinpoint meaning, by the theories of post-modernism, post-structuralism, reader-reception theory, deconstruction etc etc.
It is one thing to judge central bankers on their policies. They are economists making decisions which can at least be modelled and debated in familiar ways.
Now though we are living in a period when the bankers themselves are telling us their policy power lies in what they say about what they will do in the future. It sounds good in theory.
This in a time when communication, amplified through social media, fragmented, grabbed at, is both more available and more elusive than ever. Should Glenn Stevens be tweeting? “Popped into @Chaddy numbers down at @JB, should we #ease?”
How do we judge this new policy lever? Is there a net present value calculation for whatever it takes? How many basis points shift in shifting from easing to neutral bias?
We know these words matter and not just because central bankers say they do but because we can see real world impacts. We just don’t have the apparatus yet to analyse the complexities of how central bankers are using words nor how we coordinate the messages of different bankers around the world when they, inevitably, clash.
Maybe by paying attention to the French literary philosopher Jacques Derrida’s formulation “meaning is context bound but context is boundless”? Market analysts won’t be much happier with another of Derrida’s pronouncements: “there is nothing outside the text”.
The new transparency of central bankers is to be welcomed as is their recognition of the power of their forward looking statements. Yet as Yellen, Bernanke and Draghi all recognise, we are very newly into this period where such a lever is being consciously wielded. The outcomes bear caution.
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.