Thomas A. Lubik Federal Reserve Bank of Richmond

My favorite sentence in the paper is the last:

My favorite sentence in the paper is the last: “If nothing else, the Bank’s communication approach should make better economists.”

This nicely captures the spirit of the paper But let’s start at the beginning …

Overview Monetary policy has come a long way: Not so long ago central banks were very secretive, now they worry about communications strategy Widespread use of estimated DSGE models

Overview Monetary policy has come a long way: Not so long ago central banks were very secretive, now they worry about communications strategy Widespread use of estimated DSGE models Driven by intellectual environment: Keynesian aggregate demand thinking is passé Monetary policy has to do with controlling inflation: Hetzel (2008)

Overview Much of the advances in monetary policymaking pushed by a few SOE central banks: RBNZ: inflation targeting Riksbank: Bayesian DSGE modelling Norges Bank: transparency and communication

Overview Much of the advances in monetary policymaking pushed by a few SOE central banks: RBNZ: inflation targeting Riksbank: Bayesian DSGE modelling Norges Bank: transparency and communication Federal Reserve is slowly getting there: Hints of an inflation target Longer policy projections

April 29 FOMC Statement “The Committee […] anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”

Norges Bank and Transparency Norges Bank has published model-based endogenous interest-rate forecasts since November 2005 Transparency strategy includes: Probabilistic statements about future policy Explicit conditioning on shock distribution Openness about policy maker’s preferences Key is willingness to put a policy rule on the line: CB reacts to shocks and unforeseen developments Policy response as a general equilibrium outcome

Norges Bank and Transparency Transparency has arguably been quite successful: Reduction in interest volatility Market expectations close to forecasts

The Costs of Transparency Goodfriend’s (1986) “Monetary Mystique” Two concerns: Noise Commitment to policy path Theoretical case can be made that a better informed, but secretive trader is beneficial Concerns that central bank adds noise seem excessive

The Costs of Transparency More relevant: public might interpret interest path as a promise, deviation might be interpreted as discretion This can be handled by the right communication strategy: Fan charts Interest rate account Press conferences

The Interest Rate Account

The Benefits of Transparency Commitment is more important than transparency There are certainly decreasing returns: Objective/Target Instruments Forecasts Policy Paths Parameter estimates in the DSGE-Model? In the big scheme of things, the last steps are of second order

The Benefits of Transparency Is transparency a fair weather issue? Arguably, more open communications in the last few years gave central banks breathing room to pursue unconventional measures Transparency does not require the use of a DSGE model

NEMO Typical SOE-DSGE model with the usual bells and whistles Small-scale medium-sized model

NEMO Typical SOE-DSGE model with the usual bells and whistles Small-scale medium-sized model Striking omission (2006 version): Oil Oil investment Oil fund distributions as a residual in the current account Oil producing sector unmodelled Relative price effect on inflation

Oil

Policy Preferences Optimal policy minimizes ad-hoc loss function from a “timeless perspective” Where do the weights come from? Why not use Ramsey as the benchmark?

Policy Preferences Optimal policy minimizes ad-hoc loss function from a “timeless perspective” Where do the weights come from? Why not use Ramsey as the benchmark? Key contribution of the micro-foundation approach is not that we have optimization-based decision rules, but that we can talk about the effects of policy on welfare in a meaningful way

Back to the end: “If nothing else, the Bank’s communication approach should make better economists.” This guarantees central bank jobs for generations of future PhDs But there are deeper issues …

Who is the Audience? Public likely to be unimpressed by Bayesian DSGE models Policymakers are given an additional tool, competition with other models Optimal policy exercises in estimated DSGE models are a tool to elicit policymaker’s preferences

Monetary Policy as Engineering? DSGE-based approach creates illusion of controllability

Monetary Policy as Engineering? DSGE-based approach creates illusion of controllability We’ve been there before: were the heydays of the “large-scale macro- econometric model” Making policy was simply an optimal control problem

Monetary Policy as Engineering? DSGE-based approach creates illusion of controllability We’ve been there before: were the heydays of the “large-scale macro- econometric model” Making policy was simply an optimal control problem We know how this ended And arguably no amount of transparency could have prevented this …

Monetary Policy as Engineering! Should not get carried too much away by the use of DSGE model in the policy process Current crop of state-of-the-art DSGE models: Not rich enough Not identified Parameter and model uncertainty should be much more taken into account Bayesian model averaging Committee approach: there’s wisdom in crowds

To Summarize Norges Bank’s approach is laudable: Take recent developments in macro very seriously; can’t be all bad Provides employment for PhD economists