The Management of Expectations and “Verbal Intervention”

Expectations of the population is something that can  radically change the economic situation in the country, improve or worsen it. So the key task of the central bank is to influence the plans of market agents so that their costs savings and overall investment strategy are formed on the basis of the future value of money. National Bank of Ukraine only started its strategy of the population expectations managment. Stabilization of the national currency and the economic recovery took place including because of this practice.

How the communication policy of the National Bank of Ukraine has been changing to reflect the influence modern central banks have on economic-decision making.

In November 2013, the Czech National Bank (CNB) took an unprecedented policy action. In just one day, it managed to devalue the Czech currency (“koruna”) by more than 5% in order to ward off deflation and the zero interest rate. The koruna weakened to 27 CZK/EUR after the CNB injected €7 billion-worth of local currency in the market.

More than 1.5 years have since passed. The CNB’s policy has helped the local economy to get rid of the 2-year stagflation. The exchange rate has remained stable ever since despite the almost complete lack of interventions by the central bank. How is this possible? On the eve of the intervention, in November 2013, the CNB publicly set the cap on the koruna’s exchange rate at 27 CZK/EUR. By means of the large-scale currency intervention and the public commitment to the exchange rate threshold, the central bank has earned the trust of the public and ensured the self-correction of the market.

“Verbal intervention” is a well-known but a relatively recent central bank policy tool. For instance, up until the early nineties, the Federal Reserve System (the Fed) was perceived as an impregnable fortress by the public. “Before Greenspan many within the Fed believed that policy effectiveness depended on taking markets by surprise”, said William Poole, an economist and the former president of one of the Fed regional banks.

The main contribution to the rising independence of central banks has been made by the Nobel laureates Finn Kydland and Edward Prescott, and the famous US economist Kenneth Rogoff. They advocated the increase of the powers of central banks and suggested handing the inflation control function to central banks. The assumption behind the idea was that central bankers are more conservative than politicians and, unlike politicians, understand the devastating effects high inflation may have on economy. Yet, in order for central banks to effectively control inflation, they had to be granted the full freedom of action. In return, central banks have pledged to be more transparent and open to the public to ensure that economic agents and politicians understand CB policies correctly.

In 1994, the Fed’s Federal Open Market Committee (FOMC) announced the target interest rate (federal funds rate) and key economic indicators for the first time. Four years later, the FOMC started including different economic scenarios in its reports. Further five years down the road, it started publishing the interest rate forecast. Nowadays the whole world anticipates the Fed’s interest rate announcements.

The Columbia University Michael Woodford explains the verbal intervention mechanism in the following way. The federal funds rate is one of the key monetary policy tools that influence the value of money. Many other factors also influence the interest rates, such as the exchange rate fluctuations, assets price levels, general economic situation, not to mention the market participants and their expectations.

The key word here is “expectations”: the central bank needs to ensure that the expected future value of money has a bearing on the spending, saving and investment decisions. “It is important for the public to understand the central bank’s actions, to the greatest extent possible, in order for the monetary policy to be more effective”, writes Woodford. “Management of expectations”, “self-fulfilling forecast” are the terms that most students of economics learn in the second of third year of their studies.

How are expectations managed? Almost all of the Public Relations tools come in handy. Here are only some of the most important ones:

1. Regular public briefings on the monetary policy decisions by the central bank’s management. Senior managers make announcements in their areas of competences in strict succession. If it is the bank’s governor who makes all the key announcements, his or her absence at even the most trivial conference can trigger a market panic.
2. Regular standardised reports on inflation, monetary policy, economic situation etc., communication with the leading market experts.
3. Interviews and comments to press. Only a limited number of experts represent the central bank’s opinion and do that exclusively in their area of competence.
4. Use of web-sites and social network accounts for spreading the central bank’s announcements (e. g. The Bank of England is an active Twitter user).

The way the Czech National Bank’s media relations work is fascinating. Not only is the date of an interest rate announcement known in advance, but so is the precise time of the announcement. Journalists gather 30-60 minutes in advance in the central bank’s office, where the press-release of the decision is already waiting for them. All on-site communication with the media agencies is forbidden until the start of the conference. The journalists have the time to think over the press-release and discuss it with colleagues, prepare some questions for the central bank governor and draft a news article. It is only after the conference has begun that the journalist get their phones back and can spread the news through their media outlets.

As you can see, verbal interventions is an art. For instance, the Swiss central bank did not manage to keep the frank’s exchange rate pegged at 1.2 CHF/EUR (it was essential for Switzerland, the world banker, not to let frank get more expensive than euro). After having accumulated $480 billion in reserves, a sum equal to 70% of the country’s GDP, the central bank had to abandon the exchange rate threshold at the beginning of 2015. As a result, the frank appreciated up to 0.98 CHF/EUR (having depreciated back to 1.07 CHG/EUR since then).

Ukraine: The First Steps

The National Bank of Ukraine (NBU) has started to design its communication policy only now, for the first time since the institution was created 24 years ago. Its former fixed exchange rate policy didn’t require a fine communication policy. According to the bank’s calculations, the former management spent about $38 billion of currency reserves to keep the exchange rate at 8 UAH/USD. Yet the simple number “8” at all currency exchange bureaus was more telling than any press-release and top-management announcements. In the unavoidable event of massive devaluation (as in 2008 and the winter of 2013-2014), the NBU had no other choice but to keep pumping money into the forex market. The possibility of managing expectations was out of the question.

The status quo changed when Valeria Gontareva revealed her intention to implement the inflation targeting policy (an obligation to keep inflation within predetermined boundaries) almost immediately after being appointed as the NBU’s head in June 2014. Inflation targeting necessitates active communication with the professional market participants and the general public. The first steps in this direction could hardly be regarded as successful: the public did not understand the NBU’s public announcements and there was simply no one who could explain multiple anti-crisis measures of the central bank.

A lot has changed since then. On August 27, the NBU lowered the key interest rate for the first time in last two years. It was the NBU’s Governor who announced the decision at a briefing which was broadcast live. Gontareva explained the decision in detail and with clarity, revealing also further intended policy actions. “This is awesome on so many levels: 1. The NBU has managed to communicate its monetary policy for the first time in its history. 2. The NBU is actually conducting this policy professionally enough for the first time in its history,” commented the Reanimation Packet of Reforms expert Pavlo Kukhta.

The NBU is following in the footsteps of more experienced central banks, gradually enriching its communication policy toolkit: the NBU now holds meetings with the press, participates in professional conferences and issues quarterly inflation reports. It is working on systemising its analytical reports and has already disclosed the data about the real owners of Ukrainian banks. It has decided to radically modernize its monthly bulletin and increase its social network presence (Facebook, Twitter and Flickr). Moreover, the bank actually responds to the numerous queries by the press (the NBU has answered about 400 queries in the first half of 2015, signalling an unprecedented level of openness).

All these measures have a common goal, namely to explain the central bank’s policy and to enhance the trust the public has in its monetary policy. In the long term, they are aimed at starting to manage expectations in economy. “The Bundesbank (Germany’s central bank) has gained the trust of the people by actively communicating the rationale for its mandate and its plans to achieve it”, said the ECB’s President Mario Draghi one year ago. It is also obvious that central banks have to match words and deeds and to ensure that the never-ending press-conferences are followed by appropriate policy actions.

The Ukrainian central bank has only just embarked on this path, yet if its top-manager’s announcements were one day able to form expectations to the same degree that the Czech National Bank managed to do in 2013, its communication policy objective would be accomplished.