Tag Archives: Itay Goldstein

Central Bank Transparency: Tell ‘Em More; Keep ‘Em Guessing

U.S. Federal Reserve chairman Ben Bernanke’s decision to hold press conferences after every other Fed’s interest-setting committee meetings set us thinking about central bank transparency in general and that of the People’s Bank of China (PBOC) in particular. How much is needed for effective policy making and what impact does being more open have on which aspects of it?

Beyond doubt central banks have become more transparent over the past two decades. Publics expect more accountability from government institutions that are, for good reason, insulated from standard political oversight. Central bankers have found that being more open makes their exercise of monetary policy easier. Markets become less skittish the more they know, an assertion backed by a growing body of academic research. Communication improves the predictability of monetary policy, thereby lessening financial market volatility and contributing to a more stable economy. In particular, greater transparency improves central banks’ ability to manage inflation expectations and thus makes inflation less volatile, if not necessarily less persistent.

That benefit of transparency alone should pique the interest of the People’s Bank of China. It is less open, we would hazard, than its counterparts in the other large economies. Government has long preferred more secrecy in monetary policy to less, which leaves it with more flexibility to guide the economy. In the mid-2000s, two economists, Nergiz Dincer and Barry Eichengreen, devised a central bank transparency index covering 100 countries. New Zealand’s central bank was most open, rating a 13.5 on the index, the Bank of England was a 12, the European Central Bank was an 11.5 and the Fed a 9.5, the same as the Bank of Japan. The PBOC came in at 4.5.

That score was a huge improvement on the 1 it had rated at the start of the decade. However, an update in 2009 by Dincer and Eichengreen to their work did little to suggest much change in the absolute rankings or the broad findings that central banks in developed economies that were politically stable tended to be most transparent, and that having a flexible exchange rate was a driver for greater transparency for reasons of public accountability.

The PBOC publishes an every wider range of data and reports on its web site as befits the increasingly central role it has taken in the macro management of the economy in the 2000s, but recent research by German economist Rolf Knütter and colleagues finds that statements and press conferences are more effective than long written reports in communicating a central bank’s intentions to financial markets. Hence the bookish and, for a central banker, limelight loving Bernanke’s decision. Press conferences tend to pull out the whys of policymaking, to augment the published whats. The PBOC is reckoned to be better at revealing the whats than the whys; its economic transparency is greater than its policy transparency which in turn is greater than its procedural transparency.

The PBOC has alternative channels of internal guidance to domestic financial institutions and markets. As those internationalize and liberalize, those channels will be increasingly inadequate channels of communication. One example that has has market participants complaining about the PBOC’s transparency weaknesses is the current round of monetary tightening. The first rise in the current series of interest rate increases last October caught money markets off-guard, as did many of the subsequent rate rises and increases in banks’ reserve ratios. Volatility in money market rates has increased in the face of market uncertainty about the central bank’s tightening intentions. The surprise rate rise announced just ahead of New Year, a time when cash is in high demand, caused the benchmark money market rates to spike by a record amount (242 basis point in one day). This forced the PBOC to inject cash into the money markets, negating its attempts to dampen inflation by mopping up liquidity though raising reserve requirements.

Similarly, as the exchange rate for the yuan becomes more flexible, that will enhance the independence of monetary policy and thus the importance of transparency to increase policy credibility and the central bank’s management of inflation expectations. The transparency of the PBOC could prove an informal indicator of the progress of market-oriented reforms in monetary policy.

Not all economists believe that greater transparency is an unalloyed public good. If it reveals divisions among policy makers or a low degree of confidence in the basis of monetary policy decisions, that can rattle markets. Central banks have more information about an economy than most investors. If investors doubt the robustness of the data or the analysis on which those decisions are being made, it can alter inflation expectations. That could have a direct impact on long-term interest rates, which in turn could determine the path of current and future consumption and investment.

In the event of a speculative attack on a currency, transparency can become an even more dangerous double-edged sword. Wharton finance professor Itay Goldstein and colleagues found that if all speculators in financial markets perfectly understand a central bank’s future course of action, the central bank may not get back market signals as good as it needs in making policy decisions. That risks policy mistakes. What central bankers then need to do, Goldstein suggests, is to surround their signals with some noise, so there are conflicting interpretations of what a central bank’s intentions truly are. That bit of greater transparency, at least, Beijing’s policymakers appear to have perfected.

Overall, the benefits of more transparency to central banks are greater than the risks. The Fed’s Bernanke is playing catch-up to his European counterparts. The PBOC has even more ground to make up.


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