Central Bank Transparency Grows Under Geraats Pressure

University of Cambridge Economics Professor Petra Geraats
Geraats said in an interview, "With interest rates so low, transparency is one of the few policy instruments left.” Photographer: Chris Ratcliffe/Bloomberg

Petra Geraats experienced the opacity of central banks first-hand.

As a doctoral economics student at the University of California-Berkeley, she spent the summer of 1999 at the European Central Bank in Frankfurt. The paper she wrote said the infant institution should publish its economic forecasts.

On her return to the U.S., the ECB’s research department contacted her, asking her to remove mention of the bank from the study or postpone publication, she said. The reason: The bank’s Governing Council wasn’t ready to start publicizing its in-house outlook -- an example of “how incredibly insecure” ECB officials felt in the early days.

Geraats, now 40, kept the ECB in and the report was published through Berkeley. The bank eventually included her research in its working-paper series in January 2001 -- the same year it began announcing internal projections.

More than a decade later, Geraats, now a professor at the University of Cambridge, still hails the economic advantages of communication in monetary policy and has dedicated much of her academic career to its study. What’s changed is that more central banks are heeding her call for openness as a way of stimulating weak economic growth.

“What we now call guidance is the latest fashion in central banking and is pretty much in line with the work Petra has done,” said Charles Wyplosz, director of the International Center for Money and Banking Studies in Geneva. He’s worked with Geraats. “Ten or 15 years ago, transparency looked crazy and wasn’t accepted by most central banks, and now it’s conventional wisdom. She’s been influential in moving the guideposts.”

Inflation Goal

The Federal Reserve has adopted an inflation goal, produced more explicit economic forecasts, begun regular press conferences by Chairman Ben S. Bernanke and released the expectations of officials for the appropriate path of interest rates. Both it and the Bank of Canada have tried to map out how long monetary policy will stay easy, something the Bank of England is studying.

Such efforts mark a revolution, given that the Fed -- which turns 100 this year -- began issuing statements when it changed rates only in February 1994. It added a specific numerical target for its benchmark overnight lending rate in August 1997. Statements after each policy meeting followed in May 1999.

“With interest rates so low, transparency is one of the few policy instruments left,” Geraats said in an interview in her small, paper-strewn office. “After the financial crisis, central banks realized it is a key tool and started to make use of it.”

Transparent Theory

Geraats’s research shows transparency has a payoff.

“By indicating that a central bank is going to maintain low policy rates for a longer period of time, it can try to reduce longer-term interest rates as a result and provide further stimulus,” she said in a second interview, this time in Cambridge’s 502-year-old St. John’s College. She has been a fellow there since 2000, teaching monetary economics and international macroeconomics.

Studying how central banks communicate is the latest language test for Geraats, who at secondary school in the Netherlands studied Dutch, English, French, German and Latin as well as some Greek and Russian. She now speaks Dutch, English, French and German.

Leading Influences

It was at school that she was first drawn to economics, choosing it over astronomy. What helped make up her mind was the greater relevance of economics to the real world, said Geraats, who cites Lars Svensson, now a deputy governor at Sweden’s Riksbank, and Seppo Honkapohja of the Bank of Finland as models or mentors. She identifies research by Jordi Gali of Barcelona’s Pompeu Fabra University and by Princeton University’s Hyun Song Shin as influences.

“What I liked about economics is it’s about choice, how people make decisions,” she said. “It’s important to get decisions right, as the consequences are large.”

Astronomy remains a hobby, although poor visibility over Cambridge means she keeps her telescope at her father’s home in the Dutch province of Lindbergh. Other pursuits include playing the clarinet: She performed in the finals of a Dutch young musician competition and helped her local wind orchestra become national champion in 1995. She now enjoys weekly games of badminton with her Cambridge colleagues, while her California days gave her a taste for Ultimate Frisbee.

Excellent Research

Austria’s central bank awarded her the Klaus Liebscher Award in 2006 for excellent scientific research by a European economist under 35, five years after she was presented with a similar award by the European Economic Association.

“Economics is focused too much on thinking about models and too little is spent choosing models relevant to the real world,” Geraats said. “Academic research often ends up in dusty journals, and I felt it very important to make a difference and try to explain the real world.”

As of last month, she was one of the top 5 percent most-cited women economists on the RePec online database of 6,460 and was in the top 10 percent of all 35,653 economists registered.

Hungary’s central bank referenced her in a November study aimed at ranking the openness of central banks. A paper by economists Roman Horvath, Katerina Smidkova and Jan Zapal on what investors can learn from the votes of policy makers, published in the December International Journal of Central Banking, also mentioned her.

Human Capital

Geraats spent the first part of the 1990s at Tilburg University, writing a master’s thesis on human capital and international trade, and spent a summer working as a research economist for Ruud Lubbers, who served as Dutch prime minister from 1982 to 1994.

After graduating from Tilburg, she chose California to seek her Ph.D. in the belief that U.S. universities created “finer graduates with a larger tool kit,” whereas European students left their studies “less equipped,” she said.

At Berkeley, her professors included international economics specialist Maurice Obstfeld; David Romer, a member of the National Bureau of Economic Research panel that dates recessions; and Richard Lyons, now the dean at the Haas School of Business and formerly chief learning officer at Goldman Sachs Group Inc. Nobel laureate George Akerlof and Brad DeLong, a former U.S. Treasury official and now a high-profile blogger, also taught her.

Less Behavior

Geraats’s thesis was a series of essays on transparency in financial markets, a sign of her shift from an early interest in behavioral economics toward central banking. She also was named the outstanding graduate student instructor.

Among her inspirations was Janet Yellen, now the vice chairman of the Fed and charged with overseeing the Fed’s own openness drive. Yellen spent much of the 1990s in Washington as an adviser to President Bill Clinton and then as a Fed governor. On returning to Berkeley in 1999, she and Geraats met to evaluate the importance of communications in policy.

“The opportunity to discuss my transparency research with people like Janet Yellen at such an early stage in my career was really stimulating and provided useful insights in addition to lasting connections,” Geraats said. Such encounters also gave her heart that women could advance far in economics.

She laments the lack of gender diversity within central banks’ policy-setting panels: Neither the BOE’s nine-member Monetary Policy Committee nor the ECB’s 23-strong Governing Council currently has a female voice. More women “would give you the impression there is some diversity” of views, she said.

Contrarian Thinking

Still, she resisted entreaties herself to work at central banks after graduating, on suspicion they wouldn’t welcome contrarian thinking and she could better influence policy from the outside. In becoming a fellow at St. John’s College, she joined a club that once included BOE Governor Mervyn King. She sits on the college’s finance committee.

“She really cares about her students, reading their work and giving feedback,” said Dennis Novy, a former student who now teaches at the University of Warwick. “She’s willing to show interest in topics she doesn’t work on herself.”

Geraats coupled teaching at Cambridge with periods advising the International Monetary Fund and researching at the Riksbank and Norway’s Norges Bank as well as the Fed banks of New York and St. Louis.

Among her findings: A 2006 study she co-authored that posed the question “Does Central Bank Transparency Reduce Interest Rates?” suggested increasing transparency can lead to lower interest rates, often by about 50 basis points.

‘Stealth’ Policy

In a November 2010 paper, she said the ECB was conducting monetary policy “by stealth” through injections of liquidity into banks, and which meant its main policy rate no longer provided an accurate measure of its monetary policy stance. In a report released this month, she defended inflation targeting against criticism that it only succeeds because it’s adopted by countries with temporarily high inflation, which then recedes.

The lesson that sunshine is best is taking hold within central banks, which are looking for fresh ways to stimulate economies beyond reducing rates and buying assets.

“Research and experience demonstrate that clear and open communications also enhance the effectiveness of monetary policy,” Bank of Canada Governor Mark Carney said in a Dec. 11 speech.

Yellen, who in January said communications now play a “big role” in monetary policy, is serving at the Fed as it experiments with setting inflation and unemployment thresholds for the reversal of stimulus. It said in December rates will stay low “at least as long” as unemployment remains above 6.5 percent and if the central bank projects inflation of no more than 2.5 percent one or two years in the future.

Euro Defense

In Europe, ECB President Mario Draghi calmed investors by revealing in July he would do “whatever it takes” to defend the euro. The bank also is considering releasing minutes of policy meetings earlier than the current 30-year lag.

On March 7, he told reporters monetary policy would remain accommodative for as “long as needed,” then added that line to the main text of his April 4 policy statement.

At the Bank of Canada, Carney set a timeframe in 2009 for keeping rates low. As Bank of England governor starting in July, he has been charged by the government with studying whether to implement so-called forward guidance and the Fed’s use of thresholds.

Meantime, the Bank of Japan has begun pursuing a 2 percent inflation target over two years and started holding English-language briefings. New Governor Haruhiko Kuroda said March 4 it is necessary for the bank to better influence market expectations as it tries to defeat deflation. He told reporters yesterday it had taken all “necessary” and “possible” measures for now.

`Leading People'

Geraats is “widely cited and important,” said Barry Eichengreen, a professor of economics and political science at Berkeley, who has referenced her in his own research. “She is regarded as one of the leading people to do work on how central banks become more transparent and the effectiveness of monetary policy.”

Monetary authorities still can do more, Geraats said.

Fed officials should provide a collective judgment of where their benchmark rate is likely to be over time, rather than just saying what rate each deems will be appropriate in coming years, she said. The BOE should issue statements about its thinking even when it leaves policy unchanged, while the ECB should catch up with its peers by releasing minutes and voting records.

The biggest pending test may be how central banks withdraw their stimulus. Geraats again argues that how they inform markets will be central to the legacy of the crisis fighters. Investors may need to be persuaded not to send bond yields shooting higher as they did in 1994, or conversely may need to tighten credit, she said.

“We all know rates will go up in future, but central banks can influence the pace,” said Geraats. “Communications will be one of the key tools.”

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