BGA | BUSINESS IMPACT
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T he ECB [European Central Bank] needs to be understood by the markets that transmit its policy, but it also needs to be understood by the people whom it ultimately serves. People need to know that it is their central bank, and it is making policy with their interests at heart’ ECB President, Christine Lagarde, said in 2019. Central banks will lose their grip on inflation if they continue to overestimate how much consumers listen to their announcements. Inflation in the UK, for example, was expected to rise above 4% by the end of 2021 and it sits at a 13-year high in Europe. In the US, inflation has reached high levels too and it is leading the pack with rapid rises. These figures took inflation watchers off guard and financial journalists and investors kicked into overdrive, trying to predict what central banks would do to control it. But consumers – who drive inflation – seem unfazed, continuing to remodel their houses, indulge in retail therapy and spend roughly the same as they usually would on their food shop, as the disruption caused by the Covid-19 pandemic drags on. The disconnect between policymakers and the general public runs deep. Those in charge at the Federal Reserve System, the Bank of England, and the ECB can no longer afford to sit in ivory towers making interest rate decisions to which the public aren’t paying close attention. Today, there is a need for a serious rethink in terms of how central banks communicate with 'normal people', to ensure monetary policy remains effective. Why communication matters and how we’ve tried before Policy communication has become a key measure in the toolbox of central banks worldwide, especially during times of low nominal policy rates, that ultimately determine the funding costs of banks, such as those that many developed economies have faced over the last two decades and will arguably face going forward. Traditionally, the focus on policy communication has been to guide the expectations of financial markets and
professional forecasters and move longer- term interest rates even when conventional monetary policy is constrained because policy rates are already at their lowest level. The idea is that policy communication aimed at markets and institutions will transmit to homes and firms. At the same time, though, recent research makes clear that monetary policy is simply not getting through to ordinary people – it’s too difficult to understand and frankly, not engaging enough. Ordinary consumers, who are often economically illiterate, simply do not understand the implications of policies. Most people’s perception of what the economy is doing is wildly different to what economic theory suggests, which reduces their reactivity to policy measures. ‘More must be done to understand exactly which style, which sender, and which type of messages might increase policymakers’ ability to reach consumers’ For these reasons, since the Great Recession, central banks around the world have recognised that in times of low interest rates, households’ and firms’ choices should be influenced by managing consumers’ beliefs directly through communication. Of course, a rationale for direct communication with households and firms also exists outside these special periods to increase the trust in, and the credibility of, central banks. But despite all these good reasons to articulate policies in simple terms, central banks continue to communicate in a highly technical way, aimed mainly at financial market participants and institutions. The increased communication by the Bank of England with the public, for example, has not increased the general knowledge of the pillars of monetary policymaking since 2001. People don’t understand or follow policy announcements, instead they use the price signals they observe in their daily lives,
especially from grocery shopping, to form their inflation expectations. Most households focus on the price at the petrol pump, or the cost of milk, to inform their views of the overall price pressure. Solving these problem demands a rethink. Changing how communication is used as a policy tool will force, for the first time, central banks around the globe to understand the interplay between mass communication and policymaking. If the public can be engaged, the impact will be powerful.
The importance of trust and why it’s crumbling
Trust in central banks is important for both the credibility and perceived relevance of the independence of central banks, which determines the effectiveness of policy communication. The rising levels and acrimony of anti-market rhetoric can become a serious threat to central bank independence if the general public does not understand and support the policy measures central banks implement and if they lose their trust in these institutions. One core reason for people’s lack of trust is the widespread underrepresentation of certain demographic groups on important policy committees, such as the Federal Open Market Committee (FOMC) in the US, or the ECB board. Indeed, my research has found that women and African Americans have the lowest levels of general trust in the Federal Reserve and its willingness to foster the wellbeing of all Americans. Other research shows that expectations of inflation and the unemployment rate are, on average, least accurate for these underrepresented groups. To win consumer trust, central banks' boards would do well to start looking more like the people they represent. Research has proven that people are more responsive to central bank messages when they come from people who look like them and that those same people’s expectations of inflation become more accurate as a result. It couldn’t be clearer that the time has come to move away from the sea of sameness in banking boardrooms – for the sake of our economies. Getting it right – the role of academia Academics have worked tirelessly to dig into the issue of central bank communication and research has thrown up evidence of some central banks already dramatically changing
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