The following is an excellent excerpt from the book “THE ONLY GAME IN TOWN: Central Banks, Instability, and Avoiding the Next Collapse” by Mohamed A. El-Erian from Part 1: “The Why, How, and What of This Book” from Chapter 3: “Central Banks’ Communication Challenge” on page 7 and I quote:
“The highly abnormal is becoming uncomfortably normal.” –CLAUDIO BORIO, BANK FOR INTERNATIONAL SETTLEMENTS
“Houston in the blind. . .” –SANDRA BULLOCK IN GRAVITY
“Most people spend little if any time thinking about how central banks impact them–not only their daily lives but also in influencing (and even defining) the opportunities that their kids will have. Indeed, despite the substantial reach of these powerful institutions and the critical role they have played, there is still little societal recognition as to how much citizens have riding on their judgment, wisdom, and success–from protecting and enhancing their financial savings to securing credit and finding well-paying jobs.
The gap between awareness and reality is big, really big. It is one that cannot be justified by the irrelevance of the issues at hand (they are very relevant to our individual and collective well-beings) or by the lack of information. (Indeed, I try to highlight this point by heavily favoring references that are easily available to the general public, such as newspaper articles, rather than more obscure and less-accessible academic sources.) Yet it is a gap that is not particularly surprising, because of certain legacies of central banking.
For a very long time, central banks purposely flew well below society’s radar screens, opting to operate in obfuscating mystique. Indeed, as a Financial Times editorial put it, “Central banks used to hide their deliberations from public view more jealously than the papal conclave.”
To be fair, this was partly due to the highly technical nature of most of what they do on a daily basis. But it also reflected an important strategic choice.
Until the latter part of the 2000s, their leadership willingly opted for limited transparency as a means of protecting the institutions from the excessive interference of politicians (which interference many central bankers rightly feared, as it tended to be driven by short-term political objectives rather that longer-term societal ones). For decades, “Fedspeak”–as the peculiar wording of Federal Reserve remarks go to be known–was regarded as a “turgid dialer of English,” involving “the use of numerous and complicated words to convey little if any meaning.” It was, as Alan Greenspan, the long-serving head of the Federal Reserve (1987-2006), observed, a “language of purposeful obfuscation.” And it is one that Fed officials learned to “mumble with great incoherence.”
Chairman Greenspan’s predecessors had taken a similar approach, and done so in their own particular manner. This was especially the case for Chairman Paul Volcker, whom history books rightly celebrate as being most responsible for overcoming the inflationary curse that had crippled the United States and most of the world in the 1970s. In his case, “constructive ambiguity” was delivered with such authority and assertiveness that few had the courage to question him, and those who did often regretted their decision to do so.
But the world changed in two important ways–one had to do with the analytics of central banking, the other with its practicalities.
In their quest to cement their victory over the scourge of inflation, which had eroded living standards around the world, especially the 1970s and early 1980s, central banks realized they needed help–a realization that was backed by academic work and drove significant operational and institutional changes around the world, especially in the 1990s.
They needed a more robust degree of operational autonomy from a political system that was prone to opt for pro-inflationary actions as a means of buying short-term political support. They also needed to manage forward-looking inflationary expectations in a way that influenced wage negotiations and thus preempted excessive wage settlements that could fuel future inflation.
This led central banks to seek to influence a broader set of behaviors and expectations than had hitherto been the case, and to do so while enjoying much greater independence from their political bosses. It was no longer only about looking to directly determine the price and quantity of money. Central banks heavily got into the business of influencing expectations and the deployment of other people’s money. As noted in the Financial Times‘s editorial, “Monetary policy steers the economy through its effect on sentiment as much as any financial channel such as interest rates.”
Central banks initially opted for public inflation targets. The process started a quarter of a century ago in New Zealand, where, battling persistent high inflation, the central bank adopted a highly publicized inflation target of zero to 2 percent after it was approved by parliament. Looking back on the history of an action that started a worldwide phenomenon, Neil Irwin of The New York Times observed that this seemingly little step constituted a huge communication revolution back then: “At the time, the idea of a central bank simply announcing how much inflation it was aiming for was an almost radical idea. After all, central bankers had long considered a certain man-behind-the-curtain mystique as one of their tools of power.”
Another factor pushing for greater transparency involved the extent to which central banks were assuming greater power, responsibilities, and prominence–and, with that, the realization that the potential costs and risks of political misunderstanding had grown concurrently. Moreover, the “unrivalled power” displayed by the subsequent move into unconventional policies involving trillion-dollar/euro expansion in balance sheets “requires accountability towards politicans without caving in to their short-term needs.”
For these reasons, Chairman Greenspan’s two successors at the Fed felt a strong need to evolve this tradition. And the changes proved dramatic.
First, under Chairman Bernanke starting in 2011 and then under Chair Janet Yellen, the Fed began using press conferences to explain its decisions and thinking. It engaged in many more public forums, including having the head of the Fed appear on the CBS News show 60 Minutes and give an in-depth interview to the popular New Yorker magazine.
Second, central banks began spending a lot of time developing their approach to “forward policy guidance”–that is, indicating to markets what the probable course of future monetary policy actions would be. This effort entailed careful wording permutations (“linguistic gymnastics”), including various specification of “thresholds” and policy time periods. They evolved from covering triggering economic developments (such as the 2013 reference to a specific level of unchanged and abnormally low interest rates, and, in early 2015, “patient” to signal an interlude of at least two policy meetings before a change in policy stance).
Finally, the Fed started publishing the “blue dots,” that is, the individual forecasts of members of its policy-making Federal Open Market Committee, or FOMC. As such, markets were regularly informed of the evolution of interest rates, including “central tendencies” (though no specific names would be disclosed).
But this increased transparency was certainly not without its critics.
While politicians were keen to push for more and, in some cases, formal auditing of its decisions, some economists felt that the Fed may have already done too much: The more it tells markets about its intentions, the greater investors’ appetite to take on more risks, and do so to excessive levels, and the greater the risk of market dislocations when Fed officials would decide to change course, especially if this had to be done in an unanticipated fashion. In the process, greater communications would go from being a boost for policy making to risking Fed policy ineffectiveness.
Some individual U.S. central bankers have been more outspoken in public about the issue of potential ineffectiveness of unconventional monetary policies, and they were involved in the decision-making process albeit from a “hawkish perspective.” As Charles Plosser noted in early 2015, “The history is that monetary policy is not ultimately a very effective tool at solving real economic structural problems. It can try for a while but the problem then is that it’s only temporarily effective.”
Yet the most important shortfall has to do with the political system and the general public. Despite all that the Fed and others have done on “transparency” and “communication,” there is still quite a bit of confusion out there on the what/how/when/why of modern central banking, and the combination of these four decisive factors–that is to say, what actually comes out of central banks–remains puzzling for many people. The vast majority of the population still does not understand well what central banks do and why; they underestimate the extent to which central banks have been driving economic and financial developments, and, as such, they have only a weak handle on what lies ahead and how they will be personally and collectively affected.
By venturing so deep into the use of experimental measures to stimulate growth and jobs, central banks have opted for some immediate relief against the increasing risk down the road of both financial instability and a meaningful erosion in their credibility and political autonomy. It’s a trade-off whose prolonged reliance on “unconventional policies”–and one that already has prevailed for much longer than the central bankers themselves anticipated–results in unprecedented central bank involvement in the functioning of markets, in forcefully repressing volatility, in artifically boosting financial asset prices, in influencing how investors allocate their capital, and in impacting the distribution of income and wealth.
Of all these effects, it is the dominant influence on the pricing of stocks and bonds around the world that has attracted the most attention. In responding to my inquiry back in August 2014 as to how they assess the state of the financial markets, many of the readers of my Bloomberg View columns focused on the role of the Fed in pushing asset prices higher, be it directly through its large-scale purchases or indirectly by encouraging investors to take on more portfolio risks. They characterized the Fed as the “800-lb gorilla in the room and it looks like they are not in a hurry to leave.” In the process, the central bank is changing the “laws of physics,” spinning “straw into gold,” and sprinkling “fairy dust”–all of which lulls investors into “a state of complacency” that drives investors “into a manic phase,” thus turning “unpredictable” long-established relationships between asset classes.
This is a world that also exposes central banks to the political accusation of being quasi-fiscal” agencies in that they are seen by some as risking taxpayer money, buying government bonds that finance budget deficits, and deciding who gets taxpayer support, and doing all this without parliamentary approval or under executive order. And it is one of the reasons why some parliamentarians have sought to tighten the rein on central banks.
It hasn’t been easy for the central bankers to deal with posturing politicians who often lack a deep enough understanding of economic and monetary policy, let alone the intricate plumbing of national and international monetary systems. And even the most collected and calm central bankers, in this case Mario Draghi, the president of the ECB, have been known to lapse–albeit infrequently–into a visible state of irritation.
Commenting on the tone that President Draghi used “to upbraid a Spanish member of the European parliament,” New York Times reporters Jack Ewing and Binyamin Applebaum reminded us of a very unusual occurrence, not only for the ECB but for the vast majority of central bankers–that of Mario Draghi “raising his voice and sweeping his arm dismissively during an appearance in Parliament,” and doing so “with an irritation unusual for an otherwise supremely composed central banker.”
The historic bet on central bank policy that Western society collectively has placed these days–and that, by implication the rest of the world is materially exposed to–will succeed fully only if the trio of the United States, Europe, and Japan are able to emerge decisively from their low-growth/high-unemployment malaise, and do so without contributing to excessive inequalities or fueling financial market instability. (Note that, unlike others, I worry less about the threat of inflation down the road, something that will become clearer later in the book; nor do I worry that central banks will feel compelled to unload on markets the trillions of dollars of securities they have purchased. But I do worry, a lot, about future financial instability and what that does to economic and social well-being–agreeing with Fed chair Yellen’s remark that “a smoothly operating financial system promotes the efficient allocation of saving and investment, facilitating economic growth and employment.”)
This is an unprecedented policy configuration, and the outcome so far is mixed.”
(THE FOLLOWING IS ABOUT THE AUTHOR AND A TESTIMONIAL FROM LAWRENCE SUMMERS AND I QUOTE:
“Mohamed A. El-Erian has had an extraordinary career as an investment analyst, investor, and market commentator. His ‘new normal’ concept was prescient, provocative, and has proven out. Agree or disagree, his go-forward thoughts contained in this bracing book are well worth considering.” –LAWRENCE H. SUMMERS, former secretary of the U.S. Treasury
“MOHAMED A. EL-ERIAN is the chair of President Obama’s Global Development Council and chief economic adviser at Allianz, the corporate parent of PIMCO, where he was previously the CEO and co-CIO. He is a contributing editor at the Financial Times and a Bloomberg columnist. Earlier in his career, he served as deputy director at the International Monetary Fund, managing director at Salomon Smith Barney, and president and CEO of the Harvard Management Company. El-Erian was on Foreign Policy‘s list of Top 100 Global Thinkers for four consecutive years, and named by that journal as one of the 500 most powerful people on the planet. He is regularly on CNN, CNBC, and Bloomberg, and his writings have also appeared in Fortune, The Wall Street Journal, The Washington Post, Business Insider, Newsweek, The Atlantic, Latin Finance, Project Syndicate, and other outlets. El-Erian’s last book, When Markets Collide, was a New York Times and Wall Street Journal bestseller, won the Financial Times/Goldman Sachs Award for best business book of the year, was named as a best book of the year by The Economist, and was called a best business book of all time by The Independent. El-Erian earned his master’s degree and doctorate at Oxford University, having obtained his undergraduate degree at the University of Cambridge, where he holds an honorary fellowship at Queens’ College.”
LaVern Isely, Progressive, Overtaxed, Independent Middle Class Taxpayer and Public Citizen Member and USAF Veteran