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Central banks end era of promises

New York - The world's major central banks are returning to a more opaque and artful approach to policy-making, ending a crisis-era experiment with explicit promises that they found risked their credibility and did not substitute for action.

From Washington to London to Tokyo, the global shift from transparency to flexibility underscores the challenges central bankers face as they test the limits of what monetary policy can achieve.

The return to a more traditional policy-making approach and nuanced statements will challenge the communication skills of central bankers who have been chastened in the last year after some too-specific messages confused and disrupted financial markets.

Being an art

Complicating things on the world stage, the US Federal Reserve and the Bank of England are looking to telegraph plans and conditions for raising interest rates, while the European Central Bank and the Bank of Japan are heading the other way.

"Central banking used to be an art," said a senior official of a G7 central bank.

"It became less so once, globally, but with what's happened at the Fed and the BoE, it may be back to being an art."

Both the Fed and BoE had promised to hold interest rates near zero until their jobless rates had fallen to a particular level. However, unemployment in the United States and Britain fell much more quickly than economists expected and both central banks scrambled to replace their suddenly outdated "forward guidance".

"Too much transparency may sometimes be counter-productive. The balance is always tricky," the official said.

Central bank

The plan had been novel. After driving short-term borrowing costs to historical lows to battle the 2007-2009 financial crisis and deep recessions, western central banks began offering pledges on the future rate path in an attempt to pull down long-term borrowing costs for automobiles, homes and business expansion.

Fed chair Janet Yellen and many other policy makers routinely say the plan succeeded on that score, although other factors contributed. But Yellen, who was vice chair of the US central bank before taking the Fed's reins, is leading the charge away from specific policy forecasts.

"The idea of forward guidance was that by being transparent, you got a bigger effect on long-term rates," said Patrick Artus, global chief economist at French bank Natixis.

"But central banks take a risk on credibility," he said. "If something unexpected happens, you have to deviate from what you have been announcing."

Growing realisation

The BoE struggled with communication. In February it was forced to reconsider policy two and a half years ahead of schedule. With caveats about the economy, it had promised to keep rates low at least until the unemployment rate fell below 7%, predicting that would take three years. It took six months.

A month after the BoE's reconsideration, in March, the Fed would drop a similar pledge.

The experiences, keenly scrutinized and debated, led to a growing realisation of the dangers of offering policy commitments, said officials familiar with discussions among global central bankers.

"We have to be careful (and) certain that you do not commit to things that we're not sure we can actually produce," Alan Greenspan, Bernanke's predecessor, told the Economic Club of New York in April. "Remember, we don't forecast very well."

'From 'cheap talk' guidance to useful

The latest guidance from the Fed and BoE is far less specific.

After Yellen's first policy-setting meeting as Fed chair in March, the US central bank said rates would likely stay at rock bottom for a "considerable time" after it shelves its bond-buying program and, in a twist on qualitative guidance that leaves the Fed flexibility, it predicted rates would stay below-normal even after the economy has fully healed.

Yet Yellen sent markets tumbling when she stepped out of the Fed meeting that day and told reporters rates could rise "around six months" after a bond-buying program ends.

Steering markets

The Fed is now moving away from "cheap talk" and toward "useful guidance," said Adam Posen, a former member of the BoE's policy-setting committee who is now president of the Peterson Institute for International Economics.

"It doesn't commit you to anything, or constrain you in terms of what you are responding to," he said.

Similarly, BoE Governor Mark Carney has refused to give any clear indication of the timing of a rate hike in recent appearances, instead steering markets to scrutinise both the strength and uncertainties of the economy.

But he too has struggled to sound the right tone: investors scrambled to adjust their bets last month after Carney said they underestimated the chance of an early rate hike.


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