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All eyes in the world of finance are on Washington D.C. this week as chairman Jerome Powell will communicate the Federal Reserve’s monetary policy to the markets on Wednesday. Markets are anticipating another significant interest rate hike of 75 basis points, although some economists note that a 100 basis points increase might be in the cards as well. Regardless of the outcome of the meeting, Powell will have the important task of clearly communicating the Fed’s stance and outlook to the markets – a task that might be just as crucial and impactful as coming up with the monetary policy itself.

However, communication has not always been a key part of a central bank’s toolbox. Before the 1990’s, central banks were characterized as mysterious institutions, who would communicate as little as possible and would only discuss monetary policy within their closed circles. As a matter of fact, central banks did not even publish their interest rate decisions. At the start of the century, and following the Great Financial Crisis in 2008, central banks across the world set out plans to improve their communication to the outside world. A shift took place, from vague, opaque statements focused on a specialized audience to inclusive and transparent communication, accessible to the broader public.

This shift was based on the idea that good communication was actually beneficial for central banks. The words of a central bank and their forward guidance, do have a significant impact on how markets react and how people act in the economy, explains Gabriel Glöckler, a communications advisor at the European Central Bank, in a podcast. “If central banks communicate well, that will make their policy more effective. It comes through credibility: so when central banks say what they do and do what they say. That also includes being clear and consistent about what they aim at, how they will use their policy instruments to get there and how their actions are eventually transmitted through the real economy and have an impact out there. (…) In that sense, how we talk and communicate has become a tool of policy in itself,” he said.

A well-known example of how words can significantly impact the market is Mario Draghi’s “Whatever it takes” speech in July 2012, in the midst of the sovereign debt crisis: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” It gave the markets a clear and reassuring message, and his promise helped bring down bond yield across the eurozone and ended up creating the conditions that ended up saving the euro. “For many, that is the power of words uttered by central bankers,” Glöckler said.

In the last couple of years, central banks have been expanding their communication strategies to also reach the general public. The ECB is doing so by using more accessible vocabulary and producing concise summaries of its monetary policy in all languages of the European Union, Glöckler explained. A key aspect here is transparency. Glöckler: “The ECB is, also by international comparison, a very open and transparent central bank (…) We publish our so-called monetary policy accounts, where everyone can read how the discussion in the monetary council evolved, how different arguments were being weighed and how we eventually came to our decisions.” In addition, the central bank also publishes a multitude of models and forecasts that are accessible to the general public. Transparency should not be taken too far, however, Glöckler adds: “Swamping the public in details probably does not help the understanding of the general public. More is not always better. A central banker once said, transparency is only helpful if people can understand what you are actually saying.”

Regardless of what the Federal Reserve decide this week, it is clear that the role of properly communicating central bank policy has become more important, and are likely to become even more so as recession fears and high inflation have a significant impact on the average citizen; as a result, the stakes are higher for central banks to efficiently communicate with the markets and the broader audience. It will therefore be interesting to see how central banks expand their communication toolboxes in the coming months.

Written by Martijn van Dorp