Central bankers need to talk the talk

But in this increasingly complex world, where central banks and their market participation and regulation are steering the global economy, it is vital to understand what central bankers say – and whether that is different to what they mean. And indeed the meaning of what they don’t say.

The Reserve Bank of Australia’s Glenn Stevens is a master of the portentous utterance.

Titled “The Rising Complexity of the FOMC Statement” by Rubén Hernández-Murillo and Hannah Shell in Economic Synopses, 2014, No. 23, the paper also used a recognised methodology to determine the level of education required to understand the Fed.

In the early '90s, the FOMC statements were 50 to 200 words and required a reading grade of between nine and 14. During the reign of the notoriously verbose and opaque Alan Greenspan – “I know you think you understand what you thought I said but I'm not sure you realise that what you heard is not what I meant” – both the statements and required reading age hovered around the upper limit.

But 2008 tilted the world.

“(The statements) started to change dramatically with the onset of the financial crisis and the beginning of so-called unconventional monetary policy. By January 2009, the statements were over 400 words with reading grade levels around 16,” the authors found.

“Under Chair (Janet) Yellen, the FOMC issued five statements from March to September 2014. All five exceeded 800 words and had reading grade levels of 18 or 19, suggesting that readers would require an education level of about three years beyond a four-year college degree to understand them.”

The Fed’s eloquence has given rise to the term “Fedspeak”, an allusion to George Orwell’s dystopian novel “1984” where a totalitarian regime changes the language in order to subjugate the population, the linguistic equivalent of airbrushing out the past, a technique favoured by the Soviets.

“In George Orwell’s "1984", there was "oldspeak", "duckspeak", "doublespeak" and "newspeak". In modern central banking, there is "Fedspeak",” The Economist noted.

There are two issues here however and they have real world implications. During the 'Great Moderation' which preceded the financial crisis, times were simpler. The future looked straight forward. Therefore the Fed – and even Greenspan – could be more straightforward.

More complex times require more complicated explanations however. What they don’t require is more complex language. Indeed, ideally, the more complex the subject the more simple the language should be.

If it is not, there can be unintended and indeed counterproductive reactions.

Fed chair Yellen herself is alive to this and gave a major speech on the power of communication last year noting “communication was an independent and effective tool for influencing the economy”.

In their paper, Hernández-Murillo and Shell economist David-Jan Jansen suggest clear Fed communications help reduce volatility in financial markets. “Unclear communications, on the other hand, may cause market participants to delay important investment decisions, generating more uncertainty.”

Thus the authors conclude “increased FOMC transparency has benefitted financial markets by anchoring inflation expectations. But it also has led to longer and potentially more complex statements, which could unsettle financial markets if they are too difficult to understand”.

Lest this be thought just grist for central bank watchers, Philadelphia Federal Reserve Bank President Charles Plosser gave an important speech last week directly on the relationship between Fedspeak and market response.
Plosser, a voting member of the FOMC, said the FOMC's "forward guidance" on the path of the federal funds rate should give way to a longer range description of its "reaction function." In an interview with financial newsletter MNI, Plosser, who will retire March 1, said as the FOMC moves toward monetary "normalisation," its communications need to be revamped.

"I don't think we should be engaged in forward guidance the way we have, we should describe our reaction function," he told MNI. "You should say how you'll respond to the data as it comes in. That tells the market how you're going to react to the data. That's a form of forward guidance in its most valuable form."

Ironically, “reaction function” is not exactly an uncomplicated phrase.

Without wanting to delve into communications theory, meaning is not just what someone says – however complicated – but when and how they say it. A rebuke in private is different to a rebuke in public and central banks have always tried to balance their prudent uncertainty about what lies ahead with market reassurance – so, for example, a warning itself doesn’t precipitate an event.

In New Zealand, the Reserve Bank has been a model of explicitness about its intentions with regard to the housing market. The RBA’s Stevens favours more restrained but somehow more threatening warnings about what might happen if markets or institutions don’t behave.

The Fed though is in a unique situation. Its policies are in a very real sense global. They impact global interest rates, liquidity and currency. So it is right and proper they are subject to such intense scrutiny including about the way in which they are communicated.

The Economist of course is not dismissing this import with its comparison with Orwell. But even The Economist needs to think about how it explains itself. In 1984it could quite rightly assume its readers would know Orwell’s book quite well, even if they hadn’t read it. “Doublespeak” as a concept would be well understood. How many of its audience today would be so familiar with Orwell that The Economist’s conclusion that simplicity is “doubleplusgood” would be understood?