Communication is key to central banking. And key to that communication is the fine line between creating confusion by saying too much and creating unnecessary uncertainty by saying too little. Under its new Chairman, Kevin Warsh, the United States Federal Reserve is headed in the direction of minimalism. We think the Bank of Canada should keep talking and should also start providing projections of the path of interest rates.
Fed's new minimalist approach
Kevin Warsh presided over his first meeting of the Federal Reserve Open Market Committee last month. The policy statement, associated projection materials and press conference that followed drew more interest than the decision itself — which was to hold the target range for the federal funds rate at 3.5 to 3.75 per cent. The statement was more terse than usual and gave no hint of where the Fed was headed. Committee members submitted their usual “dot plot” projections concerning the economy, inflation and the appropriate path for the Fed’s policy rate, but Warsh himself did not. In his press conference, he announced his intention to create five different task forces to overhaul the Fed’s core procedures but offered little in the way of explanation for the rate decision.
Central bank independence and transparency
Warsh emphasized the Fed’s commitment to price stability and has also often stressed the importance of the Fed’s institutional independence. Both are laudable. But there is a fundamental tension between the commitment to independence and a much more laconic approach to communication. Some have likened this to a return to the Greenspan era (1987-2006), during which chairman Alan Greenspan, who died last month at age 100, spoke a good deal but often in a way that revealed little. In our view, reducing communication reduces transparency and accountability, which are important complements to independence.
Bank of Canada's communication strategy
In our recent C.D. Howe Institute study with our colleague Thorsten Koeppl of Queen’s University, we suggested how the Bank could tweak its communication strategy — which on balance is in good shape. For one thing, we think it should put less emphasis on different measures of core inflation, which are hard to explain and interpret, and focus more on describing how it intends to get headline inflation back to target. The Fed has a dual mandate: both an inflation target (currently two per cent) and “maximum employment.” Clear communication helps the public understand the open market committee’s views of the current state of the trade-off between these objectives. In contrast, the combination of two targets and no detailed explanation of decisions makes it difficult for Congress, the public and the markets to evaluate the Fed’s performance or hold it accountable.
According to the authors, the Bank of Canada should not follow the Fed's lead toward minimalism. Instead, it should continue its transparent approach and consider publishing its own projections for the path of interest rates, similar to the Fed's dot plots but with clearer explanations. This would enhance accountability and help markets and the public understand the Bank's policy intentions.
