November 8, 2016    3 minute read

The Credibility Of Central Banks: Why It Matters

Called Into Question    November 8, 2016    3 minute read

The Credibility Of Central Banks: Why It Matters

Nowadays, the central banks pay more attention to the planning and the details of their announcements than before. Why is it so important?

The Role Of Expectations

Over the last years, many research and academic papers have studied the role of expectations in the field of economics, and the outcome of these studies shows that these expectations are fundamental to the economy, because they form the basis for many market players’ decisions.

The central banks play a major role in shaping expectations: every announcement influences the decisions of the vast majority of economic agents. Therefore, a key role is played by every single chairman of the different central banks, not only in the implementation of monetary policy through conventional tools but also in influencing market expectations.

However, an announcement influences the expectations of market players if they believe it, i.e. the economic agents will be influenced only if the announcement is credible.

Having credibility is a necessary condition for central banks to be efficient in a dynamic world where conventional monetary policies failed in the attempt of affect the real economy.

The Behaviour Of The Fed And The BOJ

Today, central banks around the world adopt very different strategies in order to be credible.

The role of the monetary authority is of particular importance in Japan, which is challenged by the spectrum of deflation. The Bank of Japan (BOJ) has vowed to do whatever it takes to stimulate prices.

Today, a 2% level of inflation is the target of many central banks, among which the most important are the Federal Reserve (Fed), the Bank of England (BoE) and the European Central Bank (ECB).

To achieve the objective of stimulating prices and the real economy, the BOJ governor, Haruhiko Kuroda, is implementing a series of remarkable expansionary monetary policies, reducing not only the short-term interest rates but also the long-term ones.

On the other side of the ocean, the Fed officially announced that it is going to leave the interest rate of its funds constant, but it looks as if there will be an increase within the end of the year. In addition, the Fed’s chairwoman Janet Yellen explained that the macroeconomic data shapes her decisions.

Conclusion

Despite the strategies of the two central banks being very different, both institutions share the objective of being credible in order to influence expectations. On the one hand, there is a open and transparent monetary policy, following specific fiscal rules – this is the case of the BOJ, whose monetary policy appears to be clear even if it is becoming more expansive.

On the other hand, the Fed’s strategy is less clear, since the central bank is not communicating its objectives, and there are no definite and transparent monetary rules so far.

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