Silence Beats Ambiguity for Central Bankers Mulling Policy Exit

Releasing information that's open to contrasting readings can heighten market uncertainty

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Mario Draghi, president of the European Central Bank, looks on during a news conference in Frankfurt, Germany, on Thursday, March 9, 2017. 

Photographer: Alex Kraus/Bloomberg

Silence may be the best choice for central bankers if the alternative is sending vague signals susceptible to contrasting readings.

“Releasing information that is open to subjective interpretation may increase market uncertainty, especially in periods of already high financial turbulences, ” Gaetano Gaballo, an economist at the European Central Bank in Frankfurt, writes in an article published on the institution’s website on Wednesday. “In such a case, communication may not improve on silence.”

Source: European Central Bank

The conundrum described in the study is pertinent for ECB officials, who for weeks sent diverging signals about the route they’d follow to unwind extraordinary stimulus. The “cacophony” of contradictory messages -- as Executive Board member Benoit Coeure put it -- led to a spike in yields and higher volatility until President Mario Draghi intervened to quell the debate.

Economists and investors are waiting for guidance on the ECB's policy path forward when Draghi speaks after the Governing Council meeting on June 8.

Gaballo’s conclusion - which doesn't necessarily represent the views of the ECB - runs counter to a widespread theory in central banking that favors releasing “multiple sources of detailed information.” The assumption there is that even if market participants all misunderstand a piece of information in the same way, thus creating inefficiency, these misunderstandings will be smoothed out over time as more input becomes available.

“The research described in this article contradicts that view,” writes Gaballo. “It shows that even if policy announcements result in uncorrelated (mis)understandings,” noise in financial markets can still “induce correlated forecast errors, because agents look to market prices to improve their forecasts.”

One example from recent history cited by Gaballo to underpin his point is the so-called taper tantrum that followed the announcement by the Federal Reserve in 2013 that quantitative easing would soon be unwound. Investors, uncertain about how to take the signal, looked to market price movements as an indication and aligned their interpretation, creating excess volatility in financial markets.

“When information is prone to subjective interpretation, an announcement can generate more uncertainty than clarity,” Gaballo writes.

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