How can you explain the success of central banks with low inflation if public expectations can be so different?

 

Michael: In recent decades, the Fed has done such a trustworthy job to maintain low and stable inflation that nobody cares about monetary policy. Homes and companies show what we call rational disregard. In other words, households and companies don't know much about inflation, because it's not a big problem. However, the expectations of the household and the firm are more volatile. They don't know what ahead and what the inflation target is. houses

Explain why public care can damage credibility

Yuriy: Imagine living in countries with histories of hyperinflation in Germany, or Argentina, or Ukraine. Here people really understand how important it is to have an independent central bank. If the central bank succeeds greatly in keeping inflation low and stable over time, this belief can become eroded. Ironically, if the Fed's doing very well, people won't think it's a very valuable institution and you can get all sorts of pressures to finance programs or print money. You can actually create preconditions for something bad by being successful.

What is the most effective type of communication?

Michael: We tried to understand what a central bank should communicate using Finnish data. Is it tools or goals? The way to think about instruments – QE and broad-based asset buying programmes - is implemented by central banks and households and companies have to understand what they mean for inflation and consumption. Look at that versus telling them what Draghi did in 2012. ( He said:) He said I won't say what I'm going to do to you exactly, but trust me it'll be enough. This is called constructively imprecise by some. In other words, just tell them that, until we reach an unemployment rate of X percent, we will stay on the gas. If the central bank has a high degree of confidence and credibility, this could be all it takes to achieve this goal.

Are the Fed's projections a useful tool?

Yuriy: We found that people are paying attention to the current rate and perhaps a year ahead, and all that afterwards is noise. The marginal value of an additional year of data is not very high.

That goes back to what Michael described. What are we supposed to tell people? Do we have to tell them that the Fed's rate will be that number? Or should we say, "All is going to be fine. Confide in us!" Research tells us that only telling people all will be OK, all will have jobs and prices will be stable – that should suffice.

When you go to the dentist's office, he won't tell you what equipment he or she will use, how the sealant will function. Everything you're told is, "It's going to be all right." He wanted economic policy as boring as dentistry, Keynes said. Perhaps we're at this stage.

How effective is the communication between the Fed and households?

Michael: If you think of the central banking traditional goal — financial markets and professional forecasters and perhaps a small subset of the media — the Fed has done an incredible job of communicating its message. But this is not really the case when it comes to households and companies. I do not know a person who is not an economist who would be gathering information about inflation or the macroeconomy on the Fed website. Even if you forced them to read official information, discounts would be available.

Some research is being carried out by the Fed to try and develop simpler and more entertaining ways of communication with households. Think of the Bank of Jamaica reggae songs— they were extremely entertaining and showed what price stability means. The message is conveyed by the emotional connection with reggae.