The importance of monetary policy transparency is now largely taken for granted—a far cry from Alan Greenspan reportedly telling a U.S. congressional committee that “I’ve learned to mumble with great coherence. If I seem unduly clear to you, you must have misunderstood what I said.” Central banks the world over now wrestle with how to achieve better, rather than just more, transparency. To further this effort, central bank officials joined academics and IMF staff for a February 7 seminar on how to implement the IMF’s Code of Good Practices on Transparency in Monetary and Financial Policies (MFP Code).
There is broad consensus today on the importance of monetary policy transparency, and not only in countries with strong traditions of democratic accountability and central bank autonomy. As IMF Deputy Managing Director Agustin Carstens noted in his opening remarks, even countries that have not yet carried out monetary and financial policy assessments are showing increasing interest in good transparency practices. One underlying factor is undoubtedly the link between transparency, credibility, and policy effectiveness—a central theme at the seminar.
In September 1999, the IMF’s guiding ministerial body, the Interim Committee (now the International Monetary and Financial Committee), adopted the MFP Code. Since then, IMF staff have assessed transparency practices in more than sixty countries and the IMF’s Executive Board has twice reviewed this approach, which is now the subject of a forthcoming Board Paper.
What do countries hope to achieve in adopting the code? Mark Stone (IMF Monetary and Financial Systems Department) drew out the main themes emerging from country submissions, noting how the MFP Code is implemented in a range of institutional and legal settings, and that the emphasis placed on transparency varies according to country-specific circumstances. Reviewing country experiences, Stone suggested that the push for greater transparency is typically triggered by one of several developments: adoption of an inflation-targeting regime; a shift from a command to a market economy; a quickening pace of financial market development; participation in the financial sector assessment program (FSAP); or implementation of reforms in financial supervisory structures.
Benefits of transparency
While there was consensus among practitioners and academics on the importance of transparency, there was a variety of views on the benefits to be derived from implementing the MFP Code. Pablo García (Central Bank of Chile) pointed out that by fostering policymakers’ accountability, transparency can compensate for a legitimacy gap that may arise when an unelected governing body of an institution is entrusted with crucial aspects of public welfare. Among the benefits of transparency singled out by Ridha Ben Achour (Central Bank of Tunisia) was easier access to capital markets and better terms for government financing. The case studies argued that requiring a clear disclosure of the institutional allocation of responsibilities between central banks and finance ministries can enhance the coordination between monetary and fiscal policies. Absent this coordination, countries may see quasi-fiscal activities, the monetization of government deficits, overlaps between debt and liquidity management objectives, and other sources of tension undermine their monetary stability.
Monetary policy transparency has also had an impact on price stability through the channel of predictability, particularly in the face of large unanticipated shocks. Helio Mori (Central Bank of Brazil) cited an episode in his own country in which transparency helped to ease concerns when Brazil experienced external shocks, deviated from its inflation target on account of asset price developments, and ultimately saw an exchange rate depreciation. According to Andrew Hauser, Alternate IMF Executive Director for the United Kingdom, embracing openness in disclosure and developing an extensive publications program helped raise the quality of the Bank of England’s work by subjecting it to public scrutiny early on.
Of course, there are also costs associated with transparency for both producers (in terms of issuing publications, maintaining a website, and drafting minutes to clearly articulate the arguments) and users (time required to read and understand statements and publications, as well as lengthy consultative processes on changes in financial regulation). As noted by Hauser, the most problematic operational issue is how to communicate an expected outcome when that outcome is not known to any degree of certainty.
From accountability to policy effectiveness
The emphasis has now shifted from accountability to policy effectiveness, Carl Walsh (University of California, Santa Cruz) observed. In effect, the degree of institutional autonomy shapes transparency policies, determining whether the government discloses its instructions to the central bank or whether the latter is required to report on its activities. Public requests for greater accountability have led autonomous central banks to disclose policy information and eventually develop more proactive communication strategies.
While early debates on transparency placed the emphasis on accountability and the inflationary bias stemming from discretion, the focus has now shifted, Walsh explained, to policy effectiveness. Optimizing a simple Taylor rule (setting interest rates in response to two variables—inflation and deviations from potential output) brought policy outcomes closer to the efficiency frontier (the ideal trade-off between minimum achievable inflation and output variability). Qualitative changes, such as clear information on the future path of interest rate policy, now represent a shift in the efficiency frontier itself. In sum, Walsh said, policy announcements act as a commitment device, improving the policy trade-offs by anchoring inflation expectations.
Transparency and policy flexibility
The fine line between precommitment through disclosure and actions speaking louder than “constructively ambiguous” words is at the heart of the credibility paradox. For a credible central bank, greater flexibility and transparency may actually go hand in hand, so long as the public understands the communication. Governor Donald Kohn of the U.S. Federal Reserve System gave the example of a time when the Federal Open Market Committee began to disclose its “policy tilt.” After an episode in which the market overreacted to interest rate information, which undermined the Committee’s flexibility to adjust to unforeseen circumstances, the Fed moved to review disclosure practices. It subsequently limited statements to discussions of the balance of risks on inflation and output to avoid having the market build up false expectations of possible policy actions.
Kohn suggested that any possible tension between transparency and policy flexibility is less acute when the markets clearly understand the underlying conditionality of policy outcomes and the presence of considerable uncertainty. This was echoed by discussants at the seminar, especially by García, who pointed out that it was not so much tension between too much transparency and too little flexibility but rather between too much transparency and public underestimation of uncertainty.
Countercyclical policy and financial stability
García also noted that the transparency of inflation targeting, with its positive spillover effects on credibility, shifts the efficiency frontier out and provides room for monetary policy to act countercyclically or deal with financial stability issues. Educational efforts, he added, also help raise public awareness and increase understanding of the role of the policy anchor. A no-change or neutral stance is the litmus test for central bank communication strategies, particularly in emerging markets, where it is the direction of a change in interest rates rather than the actual rate that matters most for the transmission mechanism. Pierre St. Amant (Bank of Canada) also argued that as public confidence in the achievement of the inflation target grows, markets are correspondingly unlikely to overreact to disturbances. As evidence of this phenomenon, he cited the decline in output volatility in Canada after the adoption of inflation targeting.
The impact on financial stability was examined by the panel chaired by Tomas Balino (IMF Monetary and Financial Systems Department), who distinguished between ex post and ex ante transparency. Edward Offenbacher (Bank of Israel) suggested that ex post transparency is more straightforward for monetary policy since central banks routinely publish information on inflation outcomes for the purpose of sustaining accountability. Ex ante disclosure—of forecasts, for instance— is more problematic, as it may oversell analysts at the cost of introducing public confusion over targets and projections. Similarly, disclosure of foreign exchange intervention and emergency liquidity assistance tends to be ex post and is carefully designed to limit exchange rate volatility and moral hazard.
In summing up the proceedings, Hervé Ferhani (IMF Monetary and Financial Systems Department) noted that central banks now give greater attention to operational issues and the modalities of communicating with financial markets. In so doing, they are striving to implement better—rather than just more—transparency, and in doing this, he said, they are following the spirit of the MFP Code.