MNI INTERVIEW: Central Bank Uncertainty Tends To Easier Policy
MNI (ROME) - The more central bankers stress the uncertainty of the outlook the more likely they are to enact easier monetary policy, Bank of France senior economist Klodiana Istrefi told MNI.
In her paper “Interest rate uncertainty and firm decisions” Istrefi and co-authors defined “interest rate uncertainty” as the difference between predictions made in surveys by professional forecasters and actual outcomes.
“We checked how this uncertainty and this affects policy decisions and we find that there is a link: the more they speak about uncertainty, this correlates with an easier policy,” she told an MNI podcast. (Listen here or here)
“Higher interest rate uncertainty leads to a weaker economy, to weaker production and weaker investment,” she said, adding that sometimes forecasters disagree because they use different economic models and sometimes simply due to the intrinsic difficulty of economic forecasting.
“The idea is that the more clear and the more the central banks communicates about the reaction function, there will be at least less uncertainty about how the central bank will react," she said.
In other published research, Istrefi examined the frequency with which policymakers from central banks such as the Federal Reserve, the Bank of England or the European Central Bank “express surprise or that there is uncertainty” in official meeting minutes, in order to construct an index measuring the degree to which policy expectations are confirmed or otherwise.
DICTIONARIES OF UNCERTAINTY
“We look at the text and we want to catch this language … So we build like dictionaries of typical terms that they use to express this confidence or uncertainty on how things are on how things are going”, Istrefi said. (See MNI INTERVIEW: ECB Agrees On Gradual Cuts To Neutral - Centeno)
“There are times when there is a higher fraction of these surprise keywords or surprise risk. And this happens usually in times when there are recessions, around Brexit, Covid, or around when there is new policy tools that are implemented, where the share of uncertainty increases”, she said, stressing that the normal outcome from meetings is for banks to confirm their assessment of economic developments.
While the post-2020 inflation surge did not initially surprise policymakers, “uncertainty about inflation being too high came a bit delayed,” she said.
Financial markets sometimes react more strongly to intermeeting communications by members of the ECB’s Governing Council than to the statement and post-meeting press conferences, Istrefi said, pointing to another paper, and noting that the former average about 200 a year compared to only eight monetary policy meetings.
Intermeeting communication is usually “a continuation of those debates that have taken place in the meeting” or a way for policymakers to strengthen their position or to influence the market, Istrefi said, adding that context and timing was also important in determining the market reaction, and pointing to Mario Draghi’s famous "Whatever it takes" speech as an example.
“That was a speech that it didn't have a decision in itself,” she added.