A little knowledge from a bank can be a dangerous thing
Richard Adams
Last week produced a great illustration of how too much information from
a central bank can be dangerous.
Wim Duisenberg, the European Central Bank's chairman, hinted that there was room to cut
euro-zone interest rates on Tuesday — implying that the ECB could soon ease monetary
policy. But the next day Mr Duisenberg did a u-turn and poured cold water on the idea of
further rate cuts.
Reuters reported Mr Duisenberg's second set of remarks, and added that
foreign exchange dealers were unlikely to react "as the market is still confused by
Mr Duisenberg's comments."
While Mr Duisenberg's two-step was unusual among central bankers, who are generally
careful about what they reveal in public, the wider issue is: how much information should
policymakers give out in order to achieve their aims?
The trend in recent years is for central banks to become more transparent about their
decision-making processes, and more open about the data they act upon. In addition,
governments now provide far more timely and detailed data on their economies.
The idea is that if financial markets and consumers understand how a bank sets rates, then
changes in monetary policy will not cause dramatic shocks to the economy.
Ideally, consumers and traders anticipate the central bank's monetary policy changes. If
they expect interest rates to be changed in certain conditions, they may adapt their
behaviour before that occurs - reducing the bank's need to change policy at all.
But this idea of a "virtuous circle" between central bankers and the wider
economy has been challenged in a paper by Steven Morris of Yale University and Hyun Song
Shin of the London School of Economics, published in the American Economic Review.*
In Social Value of Public Information, the two academics found that greater disclosure can
have the opposite result to that intended. Where policy-makers want to see markets adjust
smoothly to new disclosures, the study concluded that more information can actually lead
to increased volatility.
"The impact of public information is large, and so is the impact of any noise in the
public signal that inevitably creep in," write Morris and Shin. "In short,
although public information is extremely effective in influencing actions, the danger
arises that it is too effective [authors' italics] at doing so."
The problem is that economic agents - consumers, businesses and traders - are likely to
over-react to the publicly available information, and so magnify the damage done by any
misleading or inaccurate announcements or sets of figures.
"By their nature, economic statistics are imperfect measurements of sometimes
imprecise concepts, and no government agency or central bank can guarantee flawless
information," the authors argue.
That would not matter so much if the central bank or government was the only source of
information. But the increased number of private sources of analysis and information make
the central banks' task even harder.
"In the highly sensitised world of today's financial markets, populated with Fed
watchers, economic analysts and other commentators of the economic scene, disclosure
policy assumes great importance. Our results suggest that private sources of information
may actually crowd out the public information by rendering the public information
detrimental to the policy maker's goal."
The result is greater volatility, not less, as a result of increased disclosures.
The Morris-Shin paper has been received with disquiet at the Bank of England, because its
findings cut across the trend towards promoting transparency.
To make matters worse, commentators such as US economist Paul Krugman have suggested that
companies in the wider economy have begun emulating the "hair-trigger"
decision-making behaviour seen in the financial markets.
"One could argue that far from making the economy more stable, the rapid responses of
today's corporations make their investment in equipment and software vulnerable to the
kind of self-fulfilling pessimism that used to be possible only for investment in paper
assets," wrote Krugman.
Central banks then face a dilemma. Their independence means they have to be accountable,
and allow their decision-making to be transparent. But in doing so, they may be feeding
the volatility they are trying to avoid.
*Steven Morris, Hyun Song Shin, "Social Value of Public
Information," American Economic Review, 52 (5), December 2002, pp.
1521–1534. |