Nigeria: IMF Tasks Central Banks To Be Explicit On Risks, Communicate Effectively On How Policy Responds To Changing Conditions
Given the high degree of uncertainty globally, the International Monetary Fund (IMF) has tasked central banks to be explicit about risks, with the goal of reflecting the degree of underlying macroeconomic uncertainty accurately.
The multilateral lender said in a world of frequent shocks, central bank communications should anchor expectations by explaining how policy responds to changing conditions, rather than committing to a fixed path.
In a new blog post titled, “Rethinking Central Bank Communication in an Uncertain World”, the Fund observed thar in a world of frequent and faster-moving shocks, where uncertainty is high and markets react instantly, central banks face a fundamental communications challenge: how to help the public understand monetary policy objectives while explaining how policy may evolve as economic conditions change.
“In this regard, explaining the policy framework, the reaction function of the central bank, and the way in which economic uncertainty and risks play into alternative scenarios have become the foundation of the central banker’s communications playbook.
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“As central banks adapt their policy frameworks and tools to a more uncertain and shock-prone world, it is only natural that they are also reassessing how best to communicate policy frameworks and talk about the conjuncture. A new IMF note explores these questions and sets out principles for effective monetary policy communication,” the post said.
It recalled that during the low-inflation era that followed the global financial crisis, communication was dominated by forward guidance, centered on precommitting to a likely future path of the policy rates.
“Such an approach, it noted, can be effective when policy is stuck at the lower bound and inflation expectations are drifting down.
The post added: “But commitments may become costly when circumstances change. Supply shocks, inflation surprises, or abrupt shifts in the balance of risks may require policymakers to adjust course.
“As a result, central bank communication has shifted toward explaining how policy will respond as economic conditions evolve and new data become available.”
The IMF remarked that a central task has therefore been communicating the reaction function: how policymakers interpret incoming data, weigh risks, and navigate tradeoffs between key central bank objectives.
“The strength of underlying inflation, the evolution of inflation expectations, and the nature of monetary policy transmission are the key inputs to the reaction function.
“Data dependence” has featured prominently: central banks emphasize what data matter, how data shape decisions, and what future contingencies may mean. The goal is to help the public understand the logic that guides a central bank’s decision-making,” it stressed.
According to the IMF, central banks convey their views on the economic outlook through forecasts and scenarios, explaining that this is crucial because policy decisions are based on where the macroeconomy is expected to go.
But forecasts, it remarked, are not promises, adding that in a shock-prone world, they are subject to tremendous uncertainty.
“If forecasts are communicated too precisely, or policy-rate projections are interpreted as commitments, revisions can be misinterpreted as policy reversals. In this context, scenarios can help illustrate how policy might respond under different economic outcomes, while reinforcing that future decisions will depend on incoming data and evolving conditions.
“Forecasts should be accompanied by a clear explanation of risks. Effectively communicating the reaction function can help the public better understand how policy may respond under alternative economic outcomes.
“By contrast, rate-path commitments should be exceptional and conditional, with clear escape clauses so that any conditional promise is clearly subordinate to the price-stability mandate.
“Clear communication can anchor expectations and support accountability. But more communication is not always better. Social media, automated news analysis, and artificial intelligence mean that central bank communications are parsed in real time.
“Too much detail can lead markets to focus excessively on decoding the central bank rather than assessing fundamentals. Hence conditionality relative to the evolving outlook is foundational.
“The goal of central bank communication is not to eliminate volatility. Rather, it is to reduce uncertainty about how the central bank will respond, limiting surprises around policy decisions.
Volatility is not, in and of itself, undesirable. When asset prices move in response to new information about incoming macroeconomic data that shape the inflation and growth outlook, markets are performing their essential price-discovery function.
“Such volatility is fostering the information content of expectations and can in turn provide information to policymakers.
“Successful communication therefore depends on fostering a better understanding of the policy framework. That means being clear about central bank objectives, the reaction function, and forecasts.
“Given the high degree of uncertainty globally, central banks need to be explicit about risks, with the goal of reflecting the degree of underlying macroeconomic uncertainty accurately,” the IMF blog post submitted..
COURTESY: AllAfrica
