Unlikely Megastars

The problem is that the public is not as well informed about macroeconomic relationships in general and monetary policy in particular. Their expectations on future variables, such as inflation, are not typically in line with rational expectations. This makes it especially important for central bankers to design their communications carefully. The question is, just how? Should they aim for fine-tuning expectations or focus on communicating their targets more generally?

CESifo Fellow Lena Dräger, Chair of Money and International Finance at the University of Hannover, examines the issue in detail in her latest CESifo Working Paper.

She starts by remarking that the idea that good communication is a vital part of monetary policymaking is not exactly new: it dates back to the 1990s. Previously, the view was that central banks should be obscure and opaque in their communications. Like old-fashioned oracles, as it were.

After a long period with low inflation and interest rates scratching the zero mark, today’s high-interest, high-inflation environment has made central bankers face the difficult task of explaining their policy to the population. The first hurdle is that the public is not well informed about what central banks do, what their targets are, or even about the concept of inflation. Second, they show little interest in learning more about these issues—and often what the central bank says flies past their ears.

Therefore, the first task is to engage the public. And for this, generating trust in the central bank is paramount, since higher trust correlates with higher accuracy in the public’s inflation expectations. But such trust is not abundant, first as a result of the 2008 financial crisis, and now because of high inflation rates hurting the purchasing power of consumers and firm managers. The issue is compounded by the fact that those with the lowest trust in the central bank are those who possess lower knowledge about inflation and monetary policy.

A key aspect that Lena found—in a previous study—was that informing consumers about general facts on inflation and how monetary policy affects the economy may cause a rise in trust. Similarly, addressing diversity in terms of gender, race or ability in central bank communication can also raise trust in the institution.

Once attention of the general public has been captured, consumers’ and firm managers’ inflation expectations can be guided effectively by providing simple and numerical information, for instance about the inflation target, the most recent inflation rate, or inflation projections.

Furthermore, the message sent by central bankers is easier to get across if their communication uses simple, short texts that relate to people’s daily lives, offering simple summaries of monetary policy decisions for the general public, with a second layer giving more in-depth content for experts.

The next hurdle is the media: they may add critique and interpretation to the central banker’s message. To avoid this, statements explaining policy decisions in relation to the current state of the economy that engage the reader personally and include facts or figures are more likely to receive balanced media coverage and less likely to be reported on critically.

In short, central bankers would do well to practice engaging more personally, and less technically—just like a rock star—with the general public in order to engender trust and enhance credibility.

Sounds like a good recipe for any kind of effective communication, really.