Central Bankers Prisoner of Policy Guidance: Cutting Research

Photographer: Mark Coote/Bloomberg

In an effort to gauge the policy’s success, the economists studied the practices of the Norwegian and New Zealand central banks, the two with the longest history of forward guidance. Close

In an effort to gauge the policy’s success, the economists studied the practices of the... Read More

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Photographer: Mark Coote/Bloomberg

In an effort to gauge the policy’s success, the economists studied the practices of the Norwegian and New Zealand central banks, the two with the longest history of forward guidance.

Central banks should be careful what they say about the future if they want flexibility to set monetary policy.

Policy makers can become “constrained” when they inform investors about the likely direction of interest rates, according to economists Nikola Mirkov of the University of St. Gallen and Norges Bank’s Gisle James Natvik. The topic is a hot issue at the moment as central bankers, including Federal Reserve Chairman Ben S. Bernanke, embrace so-called forward guidance to enhance the power of interest rates in providing stimulus.

In an effort to gauge the policy’s success, the economists studied the practices of the Norwegian and New Zealand central banks, the two with the longest history of forward guidance.

They found that both were reluctant to deviate from previous forecasts of bank policy, especially those made a quarter ahead. The behavior of the central banks was better explained by the guidance previously given than by what policy rules suggested was the best path.

“Reluctance to deviate from past forecasts might prevent policy makers from reacting sufficiently strongly to unexpected shocks,” the economists said.

The finding may help shape the debate in the U.K., given that incoming Bank of England Governor Mark Carney has spoken warmly of forward guidance. U.K. officials, including outgoing Governor Mervyn King, have warned of the risk of becoming a prisoner to past commitments.

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The rise of globalization leaves economies more prone to slides in foreign financial markets.

In a working paper published this week by the European Central Bank, economist Arnaud Mehl found 43 episodes since 1885 in which U.S. equity markets displayed unanticipated volatility.

He then studied a group of 16 countries to determine their response to those episodes. On average, there was a 20 percent drop in global stock markets in the month the U.S. shock occurred, Mehl found.

The paper may make it easier for policy makers to track which economies are vulnerable to surges in uncertainty and risk and therefore need help in avoiding financial spillovers, he said.

“The equities of economies highly open to global trade have been significantly more affected than those of more closed ones by large global stock market volatility shocks over the last 130 years,” Mehl said in the paper. “These results shed light on a neglected aspect of globalization, which creates opportunities but also heightens the exposure of economies to acute surges in global uncertainty and risk aversion.”

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Central bankers are looking to diversify their reserves, which have risen fivefold in the past decade.

Half of 67 respondents to a poll last year by the International Monetary Fund -- responsible for managing $2.2 trillion -- are considering adjusting where they place the currencies they hold.

One in seven central banks is already exposed to equity markets and 10 percent are considering creating sovereign wealth funds, according to a May 8 report by economists Aideen Morahan and Christian Mulder.

While banks hold most of their reserves in dollars, the economists found the Chinese yuan was cited as an increasingly popular choice, as were commodity-tied currencies such as the dollars of Australia and Canada.

Central bank reserves are now the equivalent of one-third of the bond markets of the 34-member Organization for Economic Cooperation and Development, the IMF said. Still, the economists said, the reserves’ composition hasn’t kept up with the evolution of the world economy.

Seventy percent of central banks said they already changed their asset allocation in the past five years, with half pulling back on their commercial bank deposits and 35 percent reducing exposure to unguaranteed bonds. In choosing investments, half considered the impact of their actions on markets and a similar proportion were looking to alter their management practices to better account for shifts in investor sentiment.

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Policy makers managing the availability of credit using so-called macroprudential tools find it easier to rein in animal spirits than to boost them.

A U.S. Treasury Department study released this week looks at 245 cases of macroprudential regulation, a term given to efforts to reduce the risk posed by the financial system as a whole rather than individual banks. Examples include introducing rules to require banks to retain certain amounts of capital or meet certain rules before lending.

It found that those policies designed to tighten credit availability do have a “notable effect,” especially if the tools being tweaked are the underwriting standards for loans, said authors Douglas J. Elliott, Greg Feldberg and Andreas Lehnert.

By contrast, policies aimed at stimulating economic activity by easing credit availability have little effect on outstanding debts.

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A less fluid labor market means fewer Americans are moving to different states, potentially reducing the economy’s flexibility to absorb shocks.

A working paper published this month by the Fed researches the decline in interstate migration since the 1980s. It argues the drop is related to a drop in the number of workers switching jobs, industry or occupation.

One reason for less churn is that the wage gains associated with transitions have declined, reducing one of the main channels of wage growth, the paper said.

“The resulting decrease in job changing may have brought about a decline in long-distance migration as fewer people move to take a new job,” said Fed economists Raven Molloy and Christopher L. Smith along with Abigail Wozniak of the University of Notre Dame. “Falling migration may be troubling if it is symptomatic of a broader decline in dynamism with the United States.”

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Almost two-thirds of the world’s central banks don’t use social media. The ones that do sometimes have reason to regret it.

A May 10 survey by Central Banking Publications, a London-based publisher, found that 60 of 181 monetary policy authorities operate either a Twitter or Facebook account.

The Bank of France is the most prolific tweeter, with 6,000 messages since it joined the site. That beat out the Federal Reserve Bank of St. Louis and the central bank of Ecuador.

When it comes to followers, the Bank of Mexico has the most with more than 107,000, almost double the Federal Reserve’s 60,000. The Fed has the largest followers-to-tweet ratio accumulating 92 followers for every 140-character missive.

The report also highlighted the perils of using social media. Bank of France Governor Christian Noyer found himself embroiled in a Twitter debate in 2011 when his central bank cited his remark that the U.K. had a bigger budget deficit and debt than the U.S. Earlier this year, the central bank of Nigeria forced the closing of more than 100 Twitter accounts claiming to be its governor, Lamido Sanusi.

To contact the reporter on this story: Simon Kennedy in London at skennedy4@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net

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