May 25, 2022
Rosa María Lastra, Queen Mary University of London Law School
Sara Dietz, Ludwig-Maximilians-Universität München/Hengeler Mueller
Montagu Norman, governor of the Bank of England in the early 20th century, reputedly lived by the motto never explain, never excuse, and that approach was still firmly in place at the Federal Reserve when I went to work there as a staff economist in 1977.
Accountability is a critical corollary of central bank independence. And communication is a necessary component of accountability. A central bank that does not communicate sufficiently with political leaders, markets and the public will not be able to justify its independence from political institutions over time.
Until the global financial crisis (GFC), communication about the monetary policy measures of the European Central Bank (ECB) was generally perceived as satisfactory and credible by financial market participants, the public and legislators. This was in part a result of the credibility enjoyed by independent central banks given the success of their anti-inflationary policies from the early 1990s to 2007 and in part a result of the societal and normative legitimacy that accompanied legal central bank independence during that period. But the world of central banking changed with the GFC. Central banks (CBs), such as the ECB, the Bank of England and the U.S. Federal Reserve System, entered uncharted territory. They have turned to unconventional monetary policy measures and have also faced unprecedented challenges given the complex dynamics between monetary, fiscal, and sovereign debt policies and renewed emphasis on financial stability. Accordingly, the role and meaning of CB communication has changed in a myriad of ways. The days Janet Yellen refers to in the epigraph are long gone.
First and foremost, communication has evolved from being a medium of simply informing the public or financial markets about what the CB has done in the past or will be doing in the future to becoming a means of making monetary policy (an instrument referred to as “forward guidance”).
Second, the importance of communication as a source of democratic legitimacy and accountability has increased with CBs reinterpreting, expanding – and, some argue, overstepping – their mandates and/or the range of tools they deploy. CB communication has become an intricate exercise in balancing diverse, and at times competing interests to enhance policy effectiveness. With CB accountability being a compulsory corollary of their independence, expanded mandates create an ever greater need for accountability and clear communication.
Third, CBs need to understand, monitor and manage the expectations of financial markets and the public when conceptualising their monetary policy strategies. Central bankers have become increasingly aware of the growing importance of CB communication with markets and other audiences.
Lastly, explaining and justifying monetary policy actions is fundamental for ensuring the credibility and legitimacy of independent CBs. Only if markets perceive the announcement of monetary policy measures as credible will the CB be able to instil the confidence it needs to conduct an effective monetary policy. With the return of inflation and inflationary expectations this trust becomes essential.
Against this background we analyse the effectiveness of the communication channels of the ECB with the public, legislators and the financial sector and address the communication challenges arising from the increased complexity and interaction between the objectives of price stability, public debt sustainability and financial stability and different policies (monetary, fiscal and macroprudential) in the pursuit of such objectives.
CB communication ought to be designed in a way that ensures an effective and accountable monetary policy, providing clarity and transparency as regards the considerations and motives that inform monetary policy decisions, in particular with regard to financial stability.
Communication plays different functions: (1) “reflection”, in which the institution itself gives an account of its own tasks as they evolve over time; (2) “translation”, explaining in common parlance to the public the measures adopted (a feature of social media) or the meaning of concepts such as “the transmission mechanism” of monetary policy; (3) “management of expectations” essential in the communication with financial markets and the public; (4) “listening” to the various stakeholders – a function of “education” and “legitimisation” whereby an independent technocratic agency explains why its actions serve its goal (or goals) and how it stays within the boundaries of its mandate.
Communication with the legislator
Communication with legislators has special significance because of the fundamental role that parliamentary accountability plays in the justification of CB independence. Effective communication can help reconnect normative legitimacy and societal legitimacy
The locus of parliamentary accountability for the ECB is European, not national. (The legal basis is Art. 284 (3) TFEU and Article 15 ESCB Statute). The ECB can explain to national parliaments the decisions taken and its rationale, but this does not imply a duty to give account.
The European Parliament (EP) holds the ECB accountable through a number of mechanisms (the Monetary Dialogue, the Annual Report, appointment procedures, questions for written answer and others). Arguably, these mechanisms are not commensurate with the expansion of ECB tasks and tools post GFC and in response to the COVID-19 pandemic. The increasing complexity of the considerations that inform monetary policy (from financial stability to climate change beyond the traditional price-stability rationale), the calibration of the appropriateness and validity of unconventional measures (their benefits and their side effects or unintended consequences), the assessment processes for calculating the amount of asset purchases, the technical deliberations that lead to monetary policy decisions (bearing in mind the limitations of the confidentiality provisions of Article 10(4) of the ESCB Statute) and the forecasting and modelling of macroeconomic developments in a changing environment exacerbate the existing information asymmetry between the European Parliament and the ECB (with a narrow primary mandate).
In the interaction between the EP and the ECB, improvements in communication and accountability can come via two main conduits: (1) internal organisation of the EP/ECON (ECON is the abbreviation for the Committee of Economic of Monetary Affairs, which is the Committee of the European Parliament that holds the Monetary Dialogue with the ECB) and (2) access to relevant ECB information and clarity in the considerations that affect the discretionary conduct of monetary policy.
In terms of the EP/ECON, (i) Members of the European Parliament (MEPs) in the ECON Committee have a wide mandate, which may lead to a lack of time and focus; (ii) the composition and size of the ECON Committee and the need to coordinate (currently) seven political groups constitute another factor that can hinder the exercise of targeted monetary policy scrutiny. Thus a subcommittee of specialist MEPs dedicated to monetary policy matters would be an improvement over the current situation.
In terms of the ECB, (i) access to information is fundamental for the exercise of effective parliamentary scrutiny and, in this regard, the ECB needs to facilitate access for the EP/ECON to relevant non-public information so that MEPs can democratically scrutinise its monetary policy decisions; (ii) given the increased use of discretion in monetary policy matters post-GFC, evidenced by the variety of considerations that go into monetary policy decisions and the range of tools adopted by the ECB since 2007, there should be clear communication about the enhanced discretion applied in the flexibility of the “medium term orientation” to cater for other considerations – as stated in the ECB’s new monetary policy strategy of 2021– in the pursuit of price stability. The ECB should communicate clearly how financial stability considerations (and others) influence the “transmission mechanism of monetary policy”.
We argue that the Monetary Dialogue has to be conceptualised as a platform not only for the provision of information to MEPs but for the debate and scrutiny of the ECB actions. The ECB has to explain and justify the measures adopted. It should be less of a lecture or conversation, as the name “dialogue” might insinuate, and more of in-depth “hearings” similar to the Congressional hearings in the US or the scrutiny undertaken by the House of Lords in its recent QE inquiry in the UK. In addition, a euro area specialised subcommittee within the ECON Committee to conduct the Monetary Dialogue would be a way to build up more technical expertise on the side of the MEPs.
In addition to the establishment of a specialised subcommittee within the ECON Committee, to strengthen the parliamentary scrutiny of monetary policy and improve the Monetary Dialogue we also propose the establishment of an Independent Evaluation Office (IEO) following the example of the IMF and the Bank of England and the revamping of the Eurosystem/ESCB Communications Committee (ECCO).
Though accountability (ex ante and ex post) is always important, it can become a routine exercise in ordinary times. Accountability is, however, essential in extraordinary times to preserve societal legitimacy. If CBs overstep their mandates, or are perceived to do so, they lose credibility and endanger their legitimacy. This not only threatens the effectiveness of monetary policy but can also undermine the general trust in the commitment of the CB to fulfil its mandate of keeping inflation under control. If this trust is eroded, it will only be a question of time until the degree of independence enjoyed by CBs gets questioned.
Communication with the public
Traditionally, communication with the general public regarding monetary policy decisions has been the channel most underappreciated and least taken care of by CBs. However, this channel of communication should not be underestimated, since the ECB’s primary mandate is targeted at a certain inflation rate measured by a consumer inflation index.
The public is much more than the mere recipient of monetary policy – it is an integral part of enacting and implementing the policy. The goal of communication with consumers and households is two-fold: (i) to assess, monitor and anchor inflation expectations, and (ii) to create a general understanding of the ECB’s monetary policy. Hence the content of the information has to be targeted to the “reaction mode” of the audience. Studies have found that non-experts only engage to a very small amount within the ECB-related Twitter traffic. It is therefore not necessary, and maybe even counter-productive, to overwhelm the general public with too much granular information in high frequency.
Communication with the general public is not only a one-way to transport information to the public, but rather a two-way-channel from which the ECB itself benefits. In the function of “listening” the ECB should also pay attention to the expectations the public has towards the CB. Perspectives on how the ECB should act have been more than heterogeneous since the GFC and the pandemic crisis. Communication is therefore also an important means to clear misunderstandings or correct wrong expectations.
National Central Banks should intensify their efforts in communicating with their citizens (a mission of “education”) in their respective languages to make sure that monetary policy decisions, which by definition are rather technical in nature, can be more easily understood by the public.
When there is “societal support” for the primary mandate (as there was in Germany post WWII), the need for communication with the public is not as acute as when societal support for the goal of price stability is fractious.
Communication with the financial markets
Communication with financial market participants and with experts in the field of finance and monetary policy – the financial sector – has always gained attention from CBs.
CBs pass on information to the financial markets in order to generate a certain behaviour in response. The more transparent CBs are with regard to their objectives and their reaction functions, the better the inflation expectations will be anchored and reflected in the prices of financial assets. But neither are CBs only “speakers” or “policymakers” nor financial markets only “listeners” or “recipients” of monetary policy. Rather, CBs also assume the position of “listeners” with regard to the signals sent by the financial markets as relevant factors in the monetary decision-making process.
In the context of the euro area, financial markets ought to understand better the considerations that affect the decisions of the ECB Governing Council, in particular how financial stability and sovereign debt concerns translate into monetary policy decisions. The practise of other CBs is heterogeneous when it comes to communicating how financial stability considerations are integrated in their monetary policy decision-making frameworks. The CBs in Norway, Canada, Sweden, New Zealand and Australia for example explicitly take financial stability considerations into account within their inflation-targeting strategies. “Financial instability escape clauses” were included in the announcement in August 2013 of the Bank of England’s explicit guidance regarding the future conduct of monetary policy.
Communication is not only a means to influence policy transmissions and a tool to gather information about the financial markets views and expectation. Since the GFC, it has developed into a monetary policy instrument of its own kind, with so called “forward guidance” being one its prominent examples. Forward guidance as an unconventional monetary policy instrument came into play when interest rates have reached the zero lower bound and conventional instruments lost their effectiveness. The ECB started this practice in 2013, when ECB President Draghi gave an outlook about the interest rate policy of the ECB in the medium term. A prominent example for the significant effects of communication is the announcement via a press release of the outright monetary transactions programme (OMT). The fact that this announcement was challenged in front of the German Federal Constitutional Court and the ECJ is proof of the factual significance of communication, which is recognised by the legal order by accepting communication (a press release) as a challengeable monetary policy instrument.
However, forward guidance has not always been able to reduce uncertainty or improve clarity in the transmission mechanism of monetary policy and communicating with financial markets has also some inherent intricacies that have to be watched carefully and taken into account when considering the phenomenon of the “echo chamber” effect or the “noisiness” of market signals. The ECB needs to be aware of these limitations and compensate with other sources, such as macroeconomic data, to build a reliable information basis for its monetary policy decisions.
Communication Design Recommendations
Drawing on the comparative experience mentioned above, in particular the “financial instability escape clauses” used by the Bank of England, the ECB can benefit from establishing a form of communication tailored to its mandate and objectives that would similarly disclose financial stability concerns and other relevant criteria within its decision-making process.
There must be clarity and transparency concerning the interaction between the primary mandate and the secondary mandate of the ECB. The GFC, the COVID-19 pandemic and the risks arising from climate change have accentuated the interdependencies and interactions between price stability, financial stability and public debt sustainability, complicating the conduct of monetary policy. Monetary policy decisions by the independent ECB must be publicly motivated so that they can be reviewed by ECJ and analysed by the EP.
Although sovereign debt ratios and borrowing needs of the Member States have a significant effect on the monetary transmission, economic growth and price stability, the ECB must ensure that its monetary policy measures do not amount to monetary financing and that exit strategies are put in place to safeguard its price stability mandate from fiscal dominance.
 This is an abridged version of a paper prepared for the European Parliament’s Committee on Economic and Monetary Affairs (ECON) as an input to the Monetary Dialogue of February 2022 between ECON and the President of the European Central Bank. The original paper is available on the European Parliament’s webpage, as part of a series of papers on “Communication, Complexity and Credibility of Monetary Policy”. Copyright remains with the European Parliament at all times. The paper is forthcoming in Banking and Finance Law Review 38 (2022). BACK TO POST
 Luis de Guindos, “Communication, expectation and monetary policy,” Intervention at the ECB policy panel of the Annual Congress of the European Economic Association, Manchester, August 27, 2019; Benoît Cœuré,“Inflation Expectations and the Conduct of Monetary Policy,” Speech at an event organised by the SAFE Policy Center, Frankfurt am Main, 11 July 11, 2019. BACK TO POST
Return to Central Bank Independence roundtable prompt.