Wednesday, June 21, 2006

Central bank transparency

There is a traditional belief that monetary authories have to be enigmatic, and that market participants have to then zealously watch the central bank to pick up crumbs of information and decipher cryptic clues. The transition from Greenspan to Bernanke, with a market that has to learn a whole new style of communication, has highlighted the poor institutional structure of US monetary policy. In a Bloomberg column a while ago, Andy Mukherjee had pointed out that the phrase "unfolding constellation of uncertainties" used by RBI had never before been seen by google. The recent RBI rate hike was a surprise to markets because there was no scheduled monetary policy meeting.

In an article Plain english versus mumbo jumbo in Business Standard today, I argue that modern monetary economics involves a powerful move towards central banks that speak in plain english and are transparent. In a well functioning monetary regime, market participants would only zealously watch the economy, not the central bank. Sound institutions involve a nuanced relationship between data releases, rules, and rate changes.

2 comments:

  1. Ajay: A couple of points. First, You are laying the foundation for future RBI watchers to lose jobs beforehand! If cental banks use simple English, where will central-bank watchers (aka Fed Watchers) will go? Second, the issue of central-bank transparency is important when investors follow the monetary authority. But that hardly happens in India. However, I like your lectures and articles and this one was no different.

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  2. Mumbo Jumbo has its advantages. Given the herd mentality of bond market, not so clear policy pronouncement slows down the bond market and give, at least to some, the benefit of doubt.

    It also gives policy makers some room to maneuver if things go in a different direction without getting bogged down to explain it's every action - as you know monetary policy making is hardly only science.

    Seeing Bernanke get into trouble after his plain talk with a reporter, I think plain talk is over rated.

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