Monetary Policy

Talk less, smile more

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“Ciao, Mario, come va?” is not what she’s saying. Source: Reuters

Aaron Burr’s advice to the young Alexander Hamilton in Lin-Manuel Miranda’s smash Broadway musical is, “Talk less, smile more.” That might have been the leitmotif for European Central Bank President Mario Draghi, Federal Reserve Chair Janet Yellen and other top central bankers when they met in Frankfurt Tuesday to talk about how much they should talk.

They discussed the uses and risks of “forward guidance” – a tool they have deployed since the 2008 financial crisis after interest rates sank to zero, depriving them of their traditional mechanism for steering monetary policy. Forward guidance is letting market participants know how the central bank views economic developments and what it expects to do about them.

For Mr. Draghi, the task is particularly complicated, because he must give the guidance in a language that neither he nor most of his constituents learned from their mothers – English. “We speak English,” said Mr. Draghi, an Italian. Official pronouncements for the euro zone are translated into nearly a score of languages, but in interviews and speeches, Mr. Draghi and other officials usually speak English.

Brexit doesn’t change anything, because Britain was never part of the euro or the ECB, so its exit is irrelevant. Rather, English is the lingua franca of the financial world and for ECB officials amongst themselves. (The same holds true for the European Union itself, which will continue to use English as a working language after Brexit.)

“It can happen, that media in their own language for their own readers always write the same thing, quite independent from the reality.”

Mario Draghi, president, European Central Bank

Central bankers have become a lot more talkative since the days when longtime Fed Chair Alan Greenspan shrouded his intentions in convoluted jargon and German officials at the Bundesbank held to the principle that silence is golden. Mr. Greenspan famously said at one point: “If I seem unduly clear to you, you must have misunderstood what I said.” For the Bundesbankers and other traditionalists, the concern was that market anticipation of a clearly telegraphed policy would rob the measure of its effectiveness.

In the wake of successive crises, however, plain speaking has become the most effective tool. Mr. Draghi’s famous declaration at the height of the euro crisis in 2012 included no ifs, ands, or buts: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” With just three words – “whatever it takes” – the central banker singlehandedly shut down speculation that the euro would break apart.

That speech was delivered in London and was clearly understood by his English audience. But speaking English to other non-English speakers can create misunderstandings. The ECB chief complained that this is especially true of attacks on the bank’s “soft” monetary policy. Critics, particularly in Germany, can miss the nuances that, sometimes willfully, get lost in translation. “It can happen that media in their own language for their own readers always write the same thing, quite independent from the reality,” he said.

The biggest risk in forward guidance, conference participants seemed to agree, was that markets are inclined to take guidance about central bank intentions as promises, and then feel betrayed when the policymakers “renege” and do something different. Ms. Yellen cited the Fed’s decision to raise short-term interest rates for the first time in a decade at the end of 2015, forecasting at the time four further hikes for 2016. “In the end, there was only one interest rate hike instead of four, and the markets felt deceived,” she said at the conference.

So now the concern has become that not following through on guidance will hurt the central bank’s credibility if the ups and downs of the economy dictate a change in plans. Forward guidance, in fact, should always be given as subject to change without notice, Ms. Yellen said, depending on what data is actually saying about the economy. That explains why the Fed has spaced out its interest rate hikes and why the ECB is still holding off on rate hikes and only slowly decreasing its asset purchases.

It was the Fed under former chair Ben Bernanke that formalized use of forward guidance as a policy tool when the crisis engulfed the financial world. That and quantitative easing – the purchase of bonds and other financial assets to create trillions in new liquidity – were the unconventional measures central banks could use to ease monetary policy when interest rates were at nearly zero.

This tactic backfired dramatically when Mr. Bernanke said in 2013 the Fed would slow down its asset purchases, unleashing the infamous “taper tantrum” of bond selling that tied the Fed’s hands for several months. Markets mistakenly assumed, Ms. Yellen said at the conference, that the Fed would also start raising rates when it began tapering its asset purchases.

Bank of England Governor Mark Carney and Bank of Japan Governor Haruhiko Kuroda also took part in the conference. The four currencies – dollar, euro, pound and yen – along with the Swiss franc account for most of the foreign exchange trading in international markets. The smallest whisper from these central banks can move markets.

Ms. Yellen at one point drew upon a standard Fed distinction between “Delphic” and “Odyssean” communications. The latter are more of definitive commitment in times of weakness or disruption (e.g. “whatever it takes”). Delphic guidance is that given in normal times when the policy framework is well understood, and is more indicative than definitive. These are times for Delphic guidance, she said.

That is perhaps the solution to Mr. Draghi’s linguistic dilemma. Rather than repeatedly answering the same questions, he should say less and counter them with a Delphic smile.

Jan Mallien covers monetary policy for Handelsblatt in Frankfurt. Darrell Delamaide is a writer and editor for Handelsblatt Global based in Washington, DC. To contact the authors:mallien@handelsblatt.comd.delamaide@extern.handelsblatt.com

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