If the public can be engaged in monetary policymaking, the impact will be powerful, says Chicago Booth’s Michael Weber. Business Schools can help by teaching future economic leaders the importance of effective communication between policymakers and the public, and equipping them with the skills to achieve that
‘The ECB needs to be understood by the markets that transmit its policy, but it also needs to be understood by the people whom it ultimately serves. People need to know that it is their central bank, and it is making policy with their interests at heart.‘
(European Central Bank (ECB) President, Christine Lagarde, 2019).
Central banks will lose their grip on inflation if they continue to overestimate how much consumers listen to their announcements. Inflation in the UK could rise above 4% this year and it sits at a 13-year high in Europe. In the US, inflation is at high levels too and it is leading the pack with rapid rises.
These figures took inflation watchers off guard and financial journalists and investors kicked into overdrive trying to predict what central banks would do to control it. But consumers – who drive inflation – seem unfazed, continuing to remodel their houses, indulge in retail therapy and spend roughly the same as they usually would on their food shop, as the Covid-19 pandemic drags on.
This disconnect between policymakers and the general public runs deep. Those in charge at the Federal Reserve System, the Bank of England and the ECB can no longer afford to sit in ivory towers making interest rate decisions that the public aren’t paying close attention to. Today, there is a need for a serious rethink regarding how central banks communicate with normal people, to ensure monetary policy remains effective.
Why communication matters and how we’ve tried before
Policy communication has become a key measure in the toolbox of central banks worldwide, especially during times of low nominal policy rates, that ultimately determine the funding costs of banks, such as those that many developed economies have faced over the last two decades and will arguably face going forward. Traditionally, the focus on policy communication has been to guide the expectations of financial markets and professional forecasters and move longer-term interest rates even when conventional monetary policy is constrained because policy rates are already at their lowest level. The idea is that policy communication aimed at markets and institutions will then transmit to households and firms.
At the same time, though, recent research makes clear that monetary policy is simply not getting through to ordinary people – it’s too difficult to understand and frankly, not engaging enough. Ordinary consumers, who are often economically illiterate, simply do not understand the implications of policies. Most people’s perception of what the economy is doing is wildly different to what economic theory suggests, which reduces their reactivity to policy measures.
For these reasons, since the Great Recession, central banks around the world have recognised that in times of low interest rates, households’ and firms’ choices should be influenced by managing consumers’ beliefs directly through communication. Of course, a rationale for direct communication with households and firms also exists outside these special periods to increase the trust in, and the credibility of, central banks.
But despite all these good reasons to articulate policies in simple terms, central banks continue to communicate in a highly technical way, aimed mainly at financial market participants and institutions. The increased communication by the Bank of England with the public, for example, has not increased the general knowledge of the pillars of monetary policymaking since 2001. People don’t understand or follow policy announcements, instead they use the price signals they observe in their daily lives, especially from grocery shopping, to form their inflation expectations. Most households focus on the price at the petrol pump, or the cost of milk, to inform their views of the overall price pressure.
Solving these problem demands a rethink. Changing how communication is used as a policy tool will force, for the first time, central banks around the globe to understand the interplay between mass communication and policymaking. If the public can be engaged, the impact will be powerful.
The importance of trust and why it’s crumbling
Trust in central banks is important for both the credibility and perceived relevance of the independence of central banks, which determines the effectiveness of policy communication. The rising levels and acrimony of anti-market rhetoric can become a serious threat to central bank independence if the general public does not understand and support the policy measures central banks implement and if they lose their trust in these institutions.
One core reason for people’s lack of trust is the widespread underrepresentation of certain demographic groups on important policy committees, such as the Federal Open Market Committee (FOMC) in the US, or the ECB board. Indeed, my research has found that women and African Americans have the lowest levels of general trust in the Federal Reserve and its willingness to foster the wellbeing of all Americans. Other research shows that expectations of inflation and the unemployment rate are, on average, least accurate for these underrepresented groups.
To win consumer trust, central banks boards would do well to start looking more like the people they represent. Research has proven that people are more responsive to central bank messages when they come from people who look like them and that those same people’s expectations of inflation become more accurate as a result. It couldn’t be clearer that the time has come to move away from the sea of sameness in banking boardrooms – for the sake of our economies.
Getting it right – the role of academia
Academics have worked tirelessly to dig into the issue of central bank communication and research has thrown up evidence of some central banks already dramatically changing the extent and modes of communication with consumers. And yet, there’s still a long way to go.
Most people remain ill-informed about the general pillars of policymaking – they do not actively attempt to obtain this information, and their expectations about policy-related variables tend to be biased and vary widely. And, yet, a growing body of work also shows that to the extent central banks can pierce the veil of ignorance, policy communication with ordinary households can become a powerful tool to steer aggregate demand.
More must be done to understand exactly which style, which sender, and which type of messages might increase policymakers’ ability to reach consumers. Moreover, all these features might differ systematically across countries, demographic groups, and over time.
Future policymakers and advisors must be aware that the most carefully crafted message and policy is bound to fail if members of the wider public are not reached, do not understand the implications for the optimal consumption-saving decisions, or simply do not care.
How can Business Schools help?
Inflation expectations determine virtually all the forward-looking decisions undertaken by households, including savings and consumption decisions, wage bargaining, labour supply, portfolio choice and more. Many Business Schools, like the University of Chicago Booth School of Business (Chicago Booth), already teach students how to adjust their decisions with inflation expectations. Not only that, but students also learn what inflation is, how it’s measured, how to form their own expectations and from there, how to make wise financial and monetary decisions.
In macroeconomics classes, students can also learn how central banks formulate their policies and how they manage and control inflation. So, at Chicago Booth – and many Business Schools across the world – students walk away from these classes with an advanced knowledge of what inflation decisions by central banks really mean. But the same can’t be said for society as a whole. The missing link today is finding ways for central banks to reach households with their policies and communications.
One way Business Schools can help is through classes in marketing which can teach future central bankers and consultants how to design simple messages that are palatable to ordinary households and identify the right channels through which to communicate these messages.
At the same time, the interdisciplinary approach of Business Schools can allow future leaders to draw on the insights across many different fields, such as psychology, behavioural economics and macroeconomics as well as marketing, to design policies that not only work in theory, but also reach ordinary households in practice through identifying modes of communication and message design that normal people care about.
The crux of that matter is that ordinary people are the ones who ultimately determine the effectiveness of monetary policy actions through their consumption, saving, and borrowing choices – which makes them the most important players in this game. Central banks need to start recognising that fact and adopt communication methods that work for ordinary people – whether this entails advertising on popular streaming platforms or getting creative with social media. The Bank of Jamaica, which has commissioned reggae songs that communicate inflation, provides one example of an attempt to use alternative methods to reach a wider audience. Perhaps central banks around the world could take a leaf out of its book.
Academics are helping central banks along this journey with crucial research, but Business Schools have an important role to play too. By educating our future economic leaders about the importance of effective communication between policymakers and the public, and equipping them with the skills to achieve that, we can ensure that the central banks of tomorrow don’t risk losing their grip on inflation.
Michael Weber is an Associate Professor of Finance at The University of Chicago Booth School of Business.