Central Bank Communication and Monetary Policy: A Survey of Theory and Evidence

Abstract

Over the last two decades, communication has become an increasingly important aspect of monetary policy. These real-world developments have spawned a huge new scholarly literature on central bank communication --mostly empirical, and almost all of it written in this decade. We survey this ever-growing literature. The evidence suggests that communication can be an important and powerful part of the central bank's toolkit since it has the ability to move financial markets, to enhance the predictability of monetary policy decisions, and potentially to help achieve central banks' macroeconomic objectives. However, the large variation in communication strategies across central banks suggests that a consensus has yet to emerge on what constitutes an optimal communication strategy. A Revolution in Thinking and PracticePrior to the 1990s, central banks were shrouded in mystery-and believed they should be. Conventional wisdom in central banking circles held that monetary policymakers should say as little as possible, and say it cryptically. In 1981, Karl Brunner (1981 wrote, with evident sarcasm:Central Banking… thrives on a pervasive impression that [it]… is an esoteric art. Access to this art and its proper execution is confined to the initiated elite. The esoteric nature of the art is moreover revealed by an inherent impossibility to articulate its insights in explicit and intelligible words and sentences.Fifteen years later, in his 1996 Robbins lectures at the London School of Economics, one of the authors of this paper (Alan Blinder (1998) Greater openness might actually improve the efficiency of monetary policy… [because] expectations about future central bank behavior provide the essential link between short rates and long rates. A more open central bank… naturally conditions expectations by providing the markets with more information about its own view of the fundamental factors guiding monetary policy…, thereby creating a virtuous circle. By making itself more predictable to the markets, the central bank makes market reactions to monetary policy more predictable to itself. And that makes it possible to do a better job of managing the economy.,Five years later, Michael Woodford (2001, pp. 307 and 312) the Federal Reserve, the ECB, and the Bank of England. Section 4 reviews the first strand of empirical research mentioned above, and Section 5 discusses the second. Finally, Section 6 provides our answers to the question of how central bank communication can contribute to the effectiveness of monetary policy and identifies avenues for future research. Why does central bank communication matter? TheoryCentral bank communication can be defined as the provision of information by the central bank to the public regarding such matters as the objectives of monetary policy, the monetary policy strategy, the economic outlook, and the outlook for future policy decisions.Nowadays, it is widely accepted that the ability of a central bank to affect the economy depends critically on its ability to influence market exp...

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