The ABCs of the ECB
Economics is not all about numbers.
In fact, in one of the most important areas of economics – central banks and monetary policy-language ranks alongside number crunching in importance.
That’s because the power to create money and therefore to influence its value thrusts economics into the forefront of people’s lives.
Retaining the confidence of people to carry out that role, means you’re going to have to be able explain what you’re doing. And not just to economists and the digital currency aficionados.
A paper published this week by economists from our own Central Bank and the European Central Bank provides fascinating insights from former euro member central bank governors and former ECB Executive Board members about the effectiveness of the ECB’s communications.
The paper has quite a few pithy quotes peppered throughout.
One from Ben Bernanke, who chaired the US Federal Reserve from 2006-2014 through the height of the financial crisis.
He said “…monetary policy is 98% talk and only 2% action.”
I personally live in dread of being about to immediately understand and explain what the 2% action entails at any given time.
However, I was slightly comforted to read later on that a report in 2017 found that “on average, a reader of the ECB and Federal Reserve monetary policy statements would need to have 13 to 15 years of formal education to understand the text.”
It very graciously doesn’t elaborate on the quality or nature of the recommended formal education.
There’s another quote from US economist and former Fed vice-chair, Alan Binder, who said “central banks will keep trying to communicate with the general public, as they should. But for the most part, they will fail.”
The paper surveyed 46 surviving former ECB Governing Council members and received detailed responses from 27.
46% of those who responded had served in their roles during or since former ECB President Mario Draghi delivered his famous ‘Whatever it Takes’ speech in 2012.
That speech marked a turning point in the Bank’s handling of the sovereign debt crisis in the euro area.
46% of respondents came from member states that were ‘stressed’ – as the authors put it – during the crisis. There were less polite terms used during that fractious time.
The paper teases out differences in responses between those members and others and former executive board members.
And just in case you forget it’s a central bank paper, there’s liberal application of ‘Fisher’s exact test of independence’ to analyse the data.
The most definitive finding that jumps out is the overwhelming view held by the former central bankers that ‘the most important objective of monetary policy communication is enhancing credibility and trust’.
If you’ll pardon the obvious metaphor here, this is the gold standard for central bankers every time they put pen to paper or open their mouths at press conferences and interviews.
During the bad old days of the crash, economist Colm McCarthy told US author Michael Lewis how people used to think there was a ‘wise old man’ minding the money in the Central Bank, which pretty much amounts to the same thing. The financial crisis put a big dent in that belief.
So, beneath the many layers of complexity involving statistics on inflation, the money supply and borrowing rates, the predominately important issue to communicate for those who have worked at the top of central banking in Europe is to reinforce ‘credibility and trust.’
Communicating the objective of ECB policy is also described as the ‘clear winner’ in terms of what’s ‘very important’ or ‘extremely important’ to get across.
After that, it gets more interesting or nuanced or central banky, if you like.
Last year, the ECB adopted a new strategy.
It switched from telling us that it can maintain the stability of prices in the euro area by targeting an inflation rate of ‘below but close to 2%.’
Now, it aims for ‘a symmetric 2% inflation rate over the medium term’ which means inflation can temporarily stray above or below the desired rate of 2%.
There’s a bit of wriggle room there.
In fact, we’re currently living through an uncomfortable wriggle room of 5% inflation at the moment, thanks to what the ECB believes are temporary factors like energy price spikes.
Interestingly, the former central bankers are equally split between whether or not a more precise inflation aim would make any difference to what expectations people would have about inflation.
There are divergent views too about putting on the record who said what in reports on the deliberations of the Governing Council.
Differing views too about how much should be said by governors of member state central banks locally and how much communication should be done centrally at ECB level.
With inflation raging, more attention has been focused on what the ECB says.
There are questions too about the long term impact of low interest rates.
It’s probably more important than ever that we understand what is being done and why it’s being done.