Central banks must clearly communicate their economic goals, not only likely interest rate paths and asset purchases, argues the 2014 Annual Report essay released today by the Federal Reserve Bank of Minneapolis. In “The Roadmap and the Destination: Words as a Monetary Policy Tool
,” the Bank’s senior vice president and research director, Sam Schulhofer-Wohl
, suggests that central bank policymakers should clearly explain not just what they intend to do, but also what they intend to achieve—the destination as well as the path.
“Describing the likely future path of policy—the roadmap, if you will—is clearly helpful in steering the economy,” writes Schulhofer-Wohl, noting that his essay expresses his own views, not necessarily those of the Federal Reserve Bank of Minneapolis or of the Federal Reserve System. “But unless policymakers also communicate clearly about the economic goals they aim to achieve—the destination—communications about the likely policy path alone leave the public more uncertain than it needs to be.”
Statements from the Federal Open Market Committee (FOMC), the Fed’s primary policymaking body, emphasize that its policies depend on how the economy evolves, observed Schulhofer-Wohl. “This data dependence, though crucial for effective policymaking, can be challenging to communicate,” he writes. He notes that while a communications strategy of describing the likely path of policy instruments such as interest rates is “clearly helpful for financial market participants…it is of limited benefit in helping ordinary households and businesses understand where the economy is headed.”
Central bank policymakers must constantly monitor the economy and adjust policy according to the unforeseeable shocks that all countries experience. “Given the vast variety of possible shocks, communicating about the desired destination is an efficient way to explain how policy will react,” explains Schulhofer-Wohl.
Schulhofer-Wohl notes that although communication came to the fore as a monetary policy tool in the aftermath of the financial crisis, it can be valuable in more ordinary times as well. “If the FOMC does not communicate its goals, the public must infer those goals from the FOMC’s actions. In the stable economic environment that existed before the crisis, such inferences were relatively easy. Today, by contrast, policymakers and the public face an unusual degree of uncertainty about economic fundamentals,” said Schulhofer-Wohl.