The Bank for International Settlements (BIS) – the home of the Basel accords on banking supervision – have today put out an interesting paper that examines the relationship between monetary policy and market prices through the lens of central bank communication. In brief:
· Central bankers use forward guidance to steer market expectations of future monetary policy moves.
· At the same time, they rely on market prices to gauge the likely path of the economy and the appropriate stance of monetary policy.
· This two-way flow between market prices and forward guidance can create a circularity, and raises questions on how best to read market signals without distorting those same prices.
The findings are surprisingly not too different from this old story about native Indians and their supposed ability predict the weather using ancient secrets!
Read on….
It was autumn, and the Indians on the remote reservation asked their new Chief if the winter was going to be cold or mild. Since he was an Indian Chief in a modern society, he had never been taught the old secrets.
When he looked at the sky, he couldn't tell what the weather was going to be. Nevertheless, to be on the safe side, he replied to his tribe that the winter was indeed going to be cold and that the members of the village should collect firewood to be prepared.
Also, being a practical leader, after several days he got an idea. He went to the phone booth, called the National Weather Service and asked, "Is the coming winter going to be cold?"
"It looks like this winter is going to be quite cold indeed," the meteorologist at the weather service responded. So the Chief went back to his people and told them to collect even more wood in order to be prepared.
A week later, he called the National Weather Service again. "Is it going to be a very cold winter?"
"Yes," the man at National Weather Service again replied, "it's definitely going to be a very cold winter."
When he looked at the sky, he couldn't tell what the weather was going to be. Nevertheless, to be on the safe side, he replied to his tribe that the winter was indeed going to be cold and that the members of the village should collect firewood to be prepared.
Also, being a practical leader, after several days he got an idea. He went to the phone booth, called the National Weather Service and asked, "Is the coming winter going to be cold?"
"It looks like this winter is going to be quite cold indeed," the meteorologist at the weather service responded. So the Chief went back to his people and told them to collect even more wood in order to be prepared.
A week later, he called the National Weather Service again. "Is it going to be a very cold winter?"
"Yes," the man at National Weather Service again replied, "it's definitely going to be a very cold winter."
The Chief again went back to his people and ordered them to collect every scrap of wood they could find.
Two weeks later, he called the National Weather Service again. "Are you absolutely sure that the winter is going to be very cold?"
"Absolutely," the man replied. "It's going to be one of the coldest winters ever."
"How can you be so sure?" the Chief asked.
The weatherman replied, "The Indians are collecting wood like crazy."
Two weeks later, he called the National Weather Service again. "Are you absolutely sure that the winter is going to be very cold?"
"Absolutely," the man replied. "It's going to be one of the coldest winters ever."
"How can you be so sure?" the Chief asked.
The weatherman replied, "The Indians are collecting wood like crazy."
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You can read the full paper here: https://www.bis.org/publ/
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