How We Got Hooked on Central Banks' Guidance
Economists have become far too dependent on the drip feed of communication from central banks. Recent events on both sides of the Atlantic show the risks.
Private-sector economists and investors may have become so used to overt guidance on when interest rates will rise -- and when they won't -- that they underestimate economic data that might otherwise scream for higher borrowing costs. For policy makers, this has costs too: A verbal miscue or a failure to follow through on guidance can mean not everyone gets the message when it really matters. Central banks aim to be a predictable, steady hand guiding economic growth.
I told myself I would soon stop writing about the Bank of Canada, but like Al Pacino standing in the kitchen in "Godfather III," I keep finding myself pulled back in. And funnily enough, it's the Bank of England -- led by a Canadian -- that's one reason.
First to the BOE. The bank's Monetary Policy Committee gave what would ordinarily be a pretty clear statement that rates are going up as soon as the next meeting, which is in November. Yet two stories from Bloomberg colleagues suggest Governor Mark Carney and his team may not have quite sold the deal. Economists are moving slowly to adjust their forecasts, according to David Goodman and Harumi Ichikura. "Slowly"? What could they be waiting for? To see how many of their profession are in the same place? Groupthink can be a powerful force in any line of work.
At least one hedge fund flatly disputes the BOE guidance. Said Haidar of Haidar Capital Management, a $325 million macro fund, told Sofia Horta E Costa: "It’s been a shot across the bow but I don’t believe them," Haidar said by phone last week. "My guess is they won’t even raise by February. The risk-reward is that they will talk tough and act slowly."
This gets at a complaint against Mark Carney, the Canadian who has had to lead the BOE in some very trying times: that he has been an inconsistent messenger of the central bank's intentions. When the BOE really wants people to believe, some are clearly having a hard time.
What does this have to do with Canada? I wrote last week about a fracas that developed after Canada lifted rates this month, contrary to the forecasts of many economists, and received a lashing from Bank of Montreal Chief Economist Doug Porter for what he said was a failure to communicate. (Here's the thing: Whatever the central bank said or didn't say, any economist could look at the public data from just days earlier, showing the economy grew a heady 4.5 percent last quarter. That should have told economists to expect a rate increase.)
The Bank of Canada spokesman issued an official rebuttal of Porter's weekly note, something unusual among major central banks.
Porter made an interesting side point. He compared the Bank of Canada unfavorably with the Federal Reserve, where he said sometimes several Fed policy makers talk on the same day.
But this doesn't necessarily make for the clarity some analysts may be seeking. If the three speakers are, for example, Kansas City's Esther George, the Minneapolis Fed's Neel Kashkari and Boston Fed President Eric Rosengren, would that leave the reader any the wiser about the center of gravity at the Federal Open Market Committee? All have dissented during their time at the Fed, especially the first two. And the entire structure of decision making is different at the Fed than at the Bank of Canada.
In any case, forward guidance is meant to be only part of the equation. It's possible for market participants to become so addicted to central bank messages that they struggle to function without it. They listen so closely to every utterance from a central bank, but they underestimate the significance of other barometers on the economy.
That, in turn, raises the bar for central banks. Commentary and an abundance of communication don't always make for the best guidance, especially when officials don't follow through or are perceived to give mixed messages.
And for economists, when officials say they are data dependent, there's a fighting chance they mean it. Nothing can be seen in isolation. Not speeches, not the absence of speeches, not projections. Events in the real world can also change central banks' plans.
It's an imprecise science. As more and more central banks remove accommodation to reflect the global upswing, it's worth bearing in mind. Nobody wants to go back to the dark ages when monetary intentions were conveyed by the raising of an eyebrow here, a selected leak to a favored stenographer there or subtle changes in opaque sentences delivered to legislators.
When we look at the Fed's famous "dot plots" this week and scrutinize the projections, let's remember there's no perfect way to divine policy direction. The Fed's guidance is part of a package. Our own judgment is part of it as well.
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Philip Gray at email@example.com