Four of the world’s top central bankers promised on Tuesday to keep openly guiding investors about future policy moves as they slowly withdraw the huge monetary stimulus rolled out during the financial crisis.
After pumping some $10 trillion into financial markets since the 2008 crisis — driving many markets to record highs — the Federal Reserve, European Central Bank, Bank of England and Bank of Japan are now trying to wean investors off easy money without causing an upset.
To do this, words will be key, the heads of the four central banks told an ECB conference on communication. It is called forward guidance in banker-speak, essentially warning gently of what is coming.
“Forward guidance has become a full-fledged monetary policy instrument,” ECB president Mario Draghi said. “Why discard a monetary policy instrument that has proved to be effective?”
Draghi and his three counterparts are at very different stages in roll-back process.
The Fed is looking at its fifth rate increase and the BOE raised its own rate this month for the first time in ten years. But the ECB is merely reducing the pace of its bond purchases, and the BOJ is still printing money at full speed, although it has signaled that no additional stimulus is likely.
Fed chair Janet Yellen agreed with Draghi that guidance has been beneficial “on balance” but stressed it should always be viewed as depending on how the economy actually develops.
“All guidance should be conditional and related to the outlook for the economy,” she said.
Banks such as the ECB often say the envisage doing something but reserve the right to change their mind if circumstances change.
History shows that preparing the ground for a withdrawal of stimulus is not always easy.
Then-Fed chair Ben Bernanke famously sent global bond markets into a tailspin in May 2013 by suggesting that bond purchases could be reduced. In the event, the “taper tantrum” meant bond buys would not be reduced for another ten months.
Draghi had his own mini-tantrum in June when he hinted that the ECB’s policy could be tweaked to reflect stronger growth. The market sell-off that followed was so big the eventual scaling back of purchases was relatively small and drawn out.
And Bank of England governor Mark Carney’s guidance on the path for interest rates has repeatedly been knocked off course by surprises in the economy, prompting one lawmaker to call him an “unreliable boyfriend”.
Keep it simple
Hyun Song Shin of the Bank of International Settlements told the ECB conference such unreliability was not necessarily all bad. Too much “predictability and gradualism” could lead investors to take on too much risk.
“Predictability and gradualism may not be a virtue if market participants take them as a commitment not to pull the rug from under their feet while they build up leverage and risk-taking,” the BIS’s head of research said.
Speaking alongside Yellen and Draghi, Bank of Japan Governor Haruhiko Kuroda said the best way to avoid misunderstandings was to keep the message simple.
“It should better be straightforward,” he said. “That’s the best way.”
His UK counterpart, Carney, stressed the importance of reaching the broader public, rather than just financial investors.
“We’re speaking to the people we serve first,” Carney said. “Three hundred thousand people read the Financial Times; there are 30 million Facebook users in the UK.”
Yellen noted that conflicting messages by different Fed policymakers risked confusing the public.
Fed governors talk on an almost daily basis, Kuroda speaks frequently and some of the ECB’s 25 rate-setters appear to live a life of their own, sometimes giving speeches at odds with the ECB’s main policy lines.
A survey by the Brookings Institute think tank found that two-thirds of Fed watchers wanted governors to speak less frequently and over half wanted Yellen to speak more instead, to streamline and focus the message.
Yellen will be replaced as Fed chair in March next year, Carney and Draghi’s terms are up in 2019, and only this week a senior aide to Japanese prime minister Shinzo Abe recommended that Bank of Japan governor Kuroda not be reappointed.