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“A little less conversation, a little more action please.” Elvis Presley
Summary: Leaks, and other non-institutional channels of communication with financial markets, should be used sparingly – excessive use risks devaluing central banks ‘ official communications frameworks and undermining their data dependent approach. Longer term, a central bank put may create more volatility, not less.
Nikileaks strikes again
OK, you remember what happened.
Prior to the latest Fed decision, we were treated to yet another installment of “Nikileaks”.
Markets had – on the basis of the data (the Fed is data dependent, yes?) – converged on a 25bp move for the Fed’s first cut.
Yet the FOMC was evidently leaning towards 50bp, so they used leaks to certain journalists and newspapers to “advise” markets that 50 was indeed in play. The market – presumably as intended – got the hint, so few were surprised by the decision when it arrived.
So what? you might say. Using leaks to the press is standard central bank practice.
Exactly.
I actually think that can be a problem.
Let me explain.
Central banks are different
Monetary policy is different from other policy areas in ways that place special responsibilities on how central banks conduct their communication.
First, for all intents and purposes monetary policy is communication. That’s the nature of the beast: most of what monetary policy does is achieved through “open mouth operations” in financial markets.
Second, financial markets trade in – and on – information with the purpose of pricing future cash flows. When every second counts, anything related to monetary policy decisions is highly sensitive information.
That’s why unlike, say, the UK budget, which one can watch “being made” almost in real time, the outcomes of central bank meetings are kept secret until they are released.
Third, most central banks in the Western world enjoy a considerable degree of institutional independence.
On the one hand, as technocratic institutions, they are absolved of the need to constantly communicate with an electorate. On the other, what they do is very important, so they need to explain themselves.
Comms principles
As a result, to maximize the effectiveness of their communication, central banks have institutionalized a number of ways to communicate with the outside world: press releases of decisions; press conferences; minutes or other kinds of accounts of their meetings; speeches; and interviews with the press.
There are rules governing all of these, the most important one being that the information is embargoed until a certain, official, release time.
Moreover, these channels are sufficient to convey policy makers’ opinions, the thought processes by which they arrive at them, the uncertainties – and any other color policy makers choose to provide.
That ensures fairness: the information is available at the same time – known in advance – to anyone that’s interested.
It also ensures impartiality – no medium or person is favored to disseminate the information. (The same is true, by the way, of market-relevant economic data releases.)
Finally, and perhaps most importantly, it ensures accuracy of the information conveyed. Policy makers can say as much, or as little, as they want in a statement, and can make sure that what they want to say is communicated in as precise a manner as they choose to.
So it’s not just about what central bankers say, but also how they say it. Not just the content, but the medium matters.
You might say, you snooze, you lose – and if you don’t follow certain news outlets you are not doing your job.
Fair enough.
Credibility concern
Yet the reason all that matters is that central banks should safeguard the credibility of their policy framework – of which communication is a crucial part – and every investor has an interest in that.
I see two problems with the use of leaks – or anything that’s outside the official framework of communication, which I’ll call non-institutional channels.
Using non-institutional channels involves a number of risks. Fairness and impartiality are not given (by design: you’re leaking to specific channels), and accuracy of information is not necessarily guaranteed.
The frequent use of non-institutional channels to convey material information can devalue the official communication framework. Why should market participants listen carefully to speeches, or study the data, if the Fed is going to leak the decision in advance anyway? (I’ll come back to this.)
The dose makes the poison
To be clear, I’m not objecting to leaks completely.
There are times when it makes sense for policy makers to channel information to the outside world “informally”, through the press. (Indeed, in a democracy, the press is very much a legitimate communications channel. And if a free press is essential for democracy, what would be the point if nobody talks to it?)
That’s why I mentioned
the frequency of the use of non-institutional channels (Nikileaks is a case in point – and I don’t want to pick here on a particular person or news outlet, I read them myself and they do a good job); and
the materiality of the information conveyed. It is one thing to communicate to the press a flavor of the internal conversation (“people are debating such-and-such”); it’s quite another to pre-empt decisions outright.
That’s my case for why leaks should be used sparingly.
But I want to go one step further, and ask: why do central bankers feel compelled to leak information to the press?
One reason may simply have to do with the internal dynamics of large committees – is it me or do Fed and ECB simply use more leaks than, say, the Bank of England?
Surprise!
Another reason is probably that central banks want to avoid surprising markets for fear of triggering excessive volatility.
This can be a valid reason – sometimes.
But I worry that central banks have elevated this to a general communications principle.
I’m not sure that’s a good idea.
Related to the previous point, it can teach the market the wrong lessons. Why put effort into understanding the data? Ultimately, this undermines central banks’ data dependent communications approach.
I think this would be a mistake, and it would be dangerous for markets, too – for much the same reasons that I think central banks should not provide forward guidance.
In the short term, it can make the market lazy and excessively dependent on central bank communication.
In the long term, a never-surprise-the-markets attitude – a kind of central bank put writ large – may be counterproductive for financial stability, if it increases risk taking and leverage. Central banks cannot, and should not, shield markets from all macro risks out there.
A potential consequence is financial dominance – a situation where central banks need to deliver whatever markets expect.
Just witness the Bank of Japan’s contrition over it’s recent rate hike – a hike which was by no means unexpected across the board (from a Bloomberg article on the BoJ’s minutes):
“The summary suggests that the BOJ will endeavor to send clearer hints before raising its benchmark rate again after the July 31 hike was criticized for precipitating market ructions that included the biggest tumble in the Nikkei 225 in its history.”
Critical mass
Which gets me to another potential reason why central banks want to avoid surprising markets: when they do, they are fiercely criticized by investors – and sometimes by politicians and the public, too (case in point, again, the Bank of Japan).
That can be thoroughly unpleasant. (I’m reliably informed that central bankers are just human.)
But sorry, if you can’t stand the heat, you shouldn’t be in the kitchen.
We need another tool
Last but by no means least, if central banks are worried about something breaking in the financial sector, perhaps this is an issue for regulation to fix – or even macroprudential policy – rather than make monetary policy communication subservient to financial stability concerns.
A little less conversation please
Ultimately, I worry that markets have become addicted to a constant drip-feed of central bank “guidance” – formal or informal. I don’t think that’s a good thing for either side.
That’s why on the popular market complaint that central banks don’t talk enough, I generally take the other side.
(I say generally, because there are exceptions. If you follow the Bank of England in any detail, you’d be forgiven for feeling that sometimes communication can be too minimalist.)
Emancipation
Central banks and financial markets need to emancipate themselves from one another. Let’s treat each other like the responsible adults we all are.
Are we not?
For questions or feedback, please comment or email me: s.andreopoulos@gmail.com - or simply reply to this email.