Why clear communication is critical in conveying matters of monetary policy

Of the many jokes that have been made about economists and their profession, one of the most piercing and yet humorous, is the quip that they are a lot that “finds something working in practice and wonders if it will work in theory”.

The joke, which is ascribed to Walter Heller — an economic advisor to two US presidents John F. Kennedy and Lyndon B. Johnson — tempts many to conclude that economists are owning up to the fact that they are too theoretical and don’t really know what will work in the real world.

Is that a justified conclusion? The answer can easily be derived from Ben Bernanke’s autobiography, The Courage to Act: A Memoir of a Crisis and its Aftermath.

And that answer is an emphatic no! When in February 2006 Bernanke took over as chairman of the Federal Reserve Board— the global financial crisis that subsequently yielded the economic meltdown was at the advanced stage of formation.

As a demonstration of the “courage to act” Bernanke started inculcating in the Fed the discipline of clear communication in matters monetary policy.

True to his modest and honest demeanour, he said of Alan Greenspan – his predecessor —as having set “the standard of excellence in economic policymaking”.

Should this make one assume that Bernanke was imagining of Greenspan’s “shoes being too big to fill”? I could argue based on a careful comparison of Bernanke’s book and Greenspan’s memoirs –The Age of Turbulence: Adventure in a New World, published in September 2007 — that the former was reluctant to fit in the latter’s shoes; he apparently was more than keen to get himself a new pair.

For the 17 years he was the Fed chairman, Greenspan’s pronouncements on monetary policy decisions were largely convoluted. Greenspan would say the federal open markets committee (FOMC)—an equivalent of the Central Bank of Kenya’s Monetary Policy Committee (MPC)—has voted to give “asymmetric directive toward tightening”.

For the same decision, Bernanke would easily say that the FOMC has authorised “a raise in interest rate that it deems necessary”.

It was 19 years too late— 17 years at the helm of the Fed and nearly two years to the publication of his memoirs —that Greenspan found it compelling to wonder:  “whatever happened to the English language”? In there lies the stark contract between the two central bankers.

One had the ability to communicate clearly and simply about a complicated problem. The other had the talent to do the exact opposite —complicate the language even when the problem may be simple!

The latter’s talent earned him celebrity status, inspiring journalist Bob Woodward to publish, in 2000, Maestro: Greenspan’s Fed and the American Boom.  It is as if the clarity of the prose in “Maestro” was meant to compensate for the pain of enduring Greenspan-speak.

I see four areas—admittedly all of which bringing out the differences in intellectual persuasion between Bernanke and Greenspan—where those insights stand to illuminate our economic management.

First is the evident conviction that inflation targeting is a compelling framework for guiding momentary policy conduct.

As Bernanke explains, those sceptical of inflation targeting simply look at the name and imagine that is implies monetary policy conduct would be deemed successful just by attempting to keep inflation close to target and praying that the rest will be fine.

In the case of the US where the central bank has a dual mandate of maximum employment and price stability, sceptics imagine that inflation targeting neglect a half of than mandate. In reality, it doesn’t.

The central bank is to attain the inflation target over a period of several years. That means that there is scope for monetary policy to respond to other aspects such as growth or employment.

In essence, the insider language (amongst economists and central bankers) for inflation targeting is “flexible inflation targeting” where longer term inflation discipline is supported by short-term flexibilities to address economic weaknesses.

Once markets and the public are confident that the central bank will act as appropriate to meet the inflation target—in other words (I can’t resists indulging myself) the public expectations of inflation are “well anchored” at the target— wage and pricing setting demand will be moderate.

This will give the central bank room to respond to, for instance, economic growth. The Central Bank of Kenya (CBK) is explicitly walking this path.

Second is the clear message that asset prices, such as stocks and housing prices, matter for monetary policy. On this, The Courage to Act navigates a delicate balance.

There are those who argue that bubbles are sector-centric, meaning that one sector—for instance housing— can be too hot while the rest of the economy is not.

Unconventional times

To raise interest rates to crush for example a looking stock bubble, goes the argument, is akin to “spanking all your children because one child (the stock market) has misbehaved”.

In other words monetary policy cannot be targeted at a single class of assets while leaving untouched other markets and the broader economy.

While admitting that a precise identification of a bubble is not easy for nobody can identify it until it pops, Bernanke contends that a central bank cannot sit on its hands while a bubble could be in formation.

The central bank can work with other regulatory agencies to fight a bubble by other means such as regulation, supervision and financial education.

Third is the recognition that unconventional times necessitate unconventional policy measures. One such policy is the so-called quantitative easing (QE), where the central bank purchases government securities or other securities from the market in order to lower interest rates and increase the money supply.

Beyond deploying QE, the Fed found itself looking carefully at its legal mandate to see whether it allows lending to non-bank institutions for it deemed that necessary. 

Fourth is the endeavour to pursue, even amidst challenges, policy coordination with other leading central banks. The challenges often arise from the fact that each central bank is keen to coordinate policy only to the extent that its self-interests are taken into account.

The chronicles of Bernanke are full of candour and in instances good humour. The lessons we can draw are not a function of practice in search of theory; they are a function of sound theory being put to practice during delicate moments.

It is a compelling read on account of the wealth of material it presents.

Mr Osoro is the director of Kenya Bankers Association Centre for Research on Financial Markets and Policy.