Threading the Needle — The Art of Central Bank Communication
This was originally written in May but in the true spirit of central banking, I’m republishing it as forward guidance for the coming year.
In the bible of central banking, Lombard Street, Walter Bagehot said that in order to stop a panic, the central bank had to lend as freely and readily as possible. That is as true today as it was in 1873. One key difference communication has accelerated, and the stakes have increased. Central bankers must not only come up with the right actions to arrest a crisis but also use the right words to stop panicky markets fluctuating. Former Chairman of the Federal Reserve Alan Greenspan became famous for his indecipherable statements in Senate hearings. Ambiguity is fine in calm times but catastrophic in a crisis. The present crisis is different to 2008, financial and political policymakers are united in their commitment to do ‘whatever it takes’.
Those three words uttered by former European Central Bank Governor Mario Draghi in 2012 are considered to have saved the Eurozone. They didn’t. It stopped a selloff of European bonds and slowed the financial crisis engulfing the Eurozone but progress was not made until the bond-buying scheme commenced. Today’s Fed Chair Jay Powell sparked a market rally of historic proportions with his promise to buy corporate bonds on March 23rd, even though the mechanism itself wouldn’t begin until May. Powell has followed the Bagehot playbook to a tee, acting quickly and lending freely and readily in the form of asset purchases for corporations, government and municipalities. He also reactivated the currency swap lines used by the Federal Reserve to stave of global financial collapse at the apex of the financial crisis.
Draghi and Powell used different forms of forward guidance to reassure markets. Forward guidance comes in two forms, Delphic and Odyssean. Delphic guidance is intended only to be informative; helping the public understand policymakers plans and economic outlook. E.g. Powell explaining that the Fed would buy ETFs. Odyssean guidance involves a promise or intention to conduct policy in a certain way, contingent on events. E.g. Draghi’s promise to do “whatever it takes”. The two forms are important and illustrate why Powell has garnered praise, but Draghi’s replacement has not.
ECB Governor Christine Lagarde has steadied the ship following a rocky start. A failure to commit to shoring up the Italian bond market (Odyssean) and the rollout of an asset purchase program that has angered Germany’s constitutional court (Delphic) are blotches on an otherwise solid performance. Lagarde is a politician, not a central banker and her introduction has been a baptism of fire. Similarly, Bank of England Governor Andrew Bailey entered the top job and immediately set about tackle the worst economic crisis to hit Britain in 300 years. The opening of deficit financing, conventionally the stuff of nightmares for economists, was announced with heavy qualifications. Bailey’s Odyssean forward guidance assured markets, economists, and conservatives that this would not become a permanent feature of central bank policy.
In Japan, the veteran Governor of the Bank of Japan Haruhiko Kuroda has taken clear and immediate action to support markets, as the BOJ has done since Kuroda was appointed in addition to offering forward guidance on their temporary nature. Despite bearish economic outlook, Japanese equities have staged a rally over the past two months in large part a reflection of Kuroda’s willingness to act but also Powell’s actions across the ocean.
Central banking is a curious profession. Appointed rather than elected, they wield extraordinary power over the world and must communicate to an array of audiences including financial markets, politicians, the media, and the general public. They must balance offering assurance while being realistic; taking bold decisive action without overreacting; and offering clear guidance on a dense policy subject. The art of central bank communication is like threading a needle, despite stumbles, the world’s preeminent central bankers have found themselves equal to the task in this unprecedented crisis.
