The Global Financial Crisis and Central Bank Speak

Introduction

Until the financial crisis, followed soon after by the ongoing sovereign debt crisis in Europe, began to pre-occupy central banks, central bank communication was dominated by an interest rate announcement. This was accompanied by a brief explanation of the outlook for the economy as well as a justification for the current stance of policy set by the monetary authority. To be sure, central banks communicated along many other dimensions. There were inflation or monetary policy reports and, increasingly, financial stability reports, among other publications produced by central banks aimed at both the well-informed and general public.

The push for greater transparency and accountability by central banks, originated in an understanding between them and their governments: monetary policy authority was responsible for its actions and could be held account for its decisions. In many, though not all, cases the agreement between central banks and governments consisted in giving the monetary authority full discretion over short-term monetary policy decisions. Longer term, and more strategic, decisions about the nature of the monetary policy regime (e.g., formal inflation targeting versus some alternative) would be left for the politicians, preferably in consultation with the monetary policy experts.

However, since at least 2008, monetary policy actions shifted away from interest rate changes to other types of announcements. As shown in Figure 1, three developments in particular characterize the dramatically changed role of the central bank policy rate since the onset of the global financial crisis. First, interest rates fell quickly as central banks, seemingly slow at first to recognize the severity of the financial shock, eventually responded by loosening the stance of monetary policy on a scale rarely seen in recent decades. Second, particularly in the economies most directly affected by the crises (i.e., the US, the UK, and the euro zone), policy rates effectively reached the so-called zero lower bound, that is, a threshold that could not be breached since ‘negative’ interest rates, even if feasible, are often deemed impractical. Finally, policy rates have remained at, or near their lowest levels, for at least three years; presently, there are few signs that central banks will raise policy rates in the near future.

Figure 1.

Central bank policy rates: RBA, BoC, RBNZ, BoE, and Fed

In this environment, the central banks most affected had few options but to devise new instruments to help their economies recover as well as, arguably, relying more heavily on their policy statements to influence expectations of financial markets and the general public. The new monetary policy tools referred to as ‘unconventional’, together with greater reliance on verbal aspects of central banks actions, arguably complicated the communications strategy of central banks.

This paper considers whether one can detect a change in the language that five central banks have used to communicate their actions and elements of their outlook since the events of 2008. The environment of historically low interest rates, the introduction of a panoply of actions that served to loosen monetary policy even when the zero lower bound was reached, as well as fending off criticisms from both politicians and the public about whether their policies would stoke future inflation, if not a renewed financial crisis, might be expected to conspire to create a change in the tone of central bank’s verbal communications. Of course, this assumes that the shock of a financial crisis on a global scale would influence how central banks communicate their actions to the public. Yet a case can also be made that, to avoid the appearance of panic or an inability to comprehend the seriousness of the situation, as well as convey competence and an aggressive response to the severe economic shock affecting the major advanced economies, central banks may well have chosen to follow a ‘steady as she goes’ approach in their communications practices. Such a view might be taken as consistent with a more strategic view of central bank behavior wherein the central bank prefers not to fully divulge the underlying truth about the state of the economy as a device to influence expectations in the direction of ending crisis conditions that may pervade thinking, say, in financial markets.