And then the Reserve Bank does it again...

And then the Reserve Bank does it again...

The decision by the Reserve Bank's Monetary Policy Committee (MPC) last week to keep the repo rate unchanged caught most people on the wrong foot. Although there had been general consensus among analysts that the Bank would cut the repo rate by 50 basis points, at the news conference after the MPC meeting the governor of the Bank, Mr Tito Mboweni, indicated that the committee had not spent much time on discussing that possibility.

It is therefore evident that economists and market participants, compared with the members on the MPC, were definitely not on the same page.

This was not the first time the Reserve Bank had surprised the market with its decisions – the most well-known example is probably the interest rate cut in Augustus 2004 when, only two months earlier, Mr Mboweni had stated categorically that there would be no further cuts. At the time the reason given for the about-turn was that the facts had changed in the meantime and had necessitated a change in the policy stance.

The same reason would not be valid this time, as the news flow in the month following the previous MPC meeting had not been such that it would have made a policy change unavoidable. This can only mean that there must have been a serious communication gap.

Last week's decision inevitably raises the question of Mr Mboweni's statement after the previous MPC meeting on 28 May 2009 that any further significant interest rate cuts were unlikely. This statement could be interpreted in a number of ways, which is exactly what happened.

In response to this I wrote as follows in my previous commentary:

“I wholeheartedly agree with the governor of the Reserve Bank, Mr Tito Mboweni, that further significant rate cuts are unlikely – inflation simply remains too high.

However, I must say I do have a problem with the way in which this very important statement was made. In my opinion any indication of the future policy stance should not be given during the question-and-answer session following the Monetary Policy Committee meeting. It should be part of the official written statement so that it can be duly debated by the committee and the wording carefully considered in order to send out a clear, unambiguous message."

The apparent confusion about last week's interest rate decision underlines this point.

I must add immediately that I do not believe any central bank, including the SA Reserve Bank, should always announce its next decision beforehand. (In the days of Alan Greenspan the American Federal Reserve Board did in fact do this for long periods of time.) But the Bank's indications of the likely future direction of monetary policy do form an important part of the policy transmission mechanism, which means the effectiveness of monetary policy could be increased by consciously manipulating interest rate expectations – important economic decisions are based not so much on the current level of interest rates but rather on expectations regarding the future course thereof.

I am also of the opinion that surprises, especially negative surprises, on the part of the Central Bank are inappropriate in the midst of a recession, with business and consumer confidence at a low. As it is there is enough uncertainty for policy makers not to add to it.

For some time now I have not been satisfied with the current format of the statements issued by the MPC after its meetings. To my mind they are unnecessarily long, contain too much information already known, and the connection between the economic discussion and the interest rate decision is often not clear.

In my opinion the communication value of the MPC statements could be enhanced considerably but shortening them and sticking to only three points: firstly, the MPC's decision, secondly, the reasons for the decision, and thirdly, the most likely direction of monetary policy in the near term. Any additional information the Bank wishes to provide could be mentioned in an annexure.

But perhaps the real question is whether the MPC should not rather explain its decisions by releasing the minutes of its meetings, instead of by means of news conferences at which the text is not as well considered and the message that is conveyed depends on journalists' subjective interpretation of what has been said.

A further facet of a central bank's communication is the information it discloses about the voting at the policy committee meetings. Some central banks go as far as mentioning by name the individual members of the policy committee and how they voted. Others disclose only the overall voting result. The argument against this type of disclosure is that it might inhibit the members of the policy committee.

Although the Reserve Bank does not disclose the result of the MPC's "voting" (in fact, in the past the bank has emphasised that the MPC does not vote on interest rate decisions but reaches consensus through debate), nowadays an indication of the division of opinions in the MPC and all the options that were considered, is given more and more often at the news conference following the MPC meetings.

For example, last week Mr Mboweni stated that, if it depended on him, there would be no further interest rate cuts, but that the other members of the MPC did not necessarily agree with him. In May he said that some of the MPC members were in favour of a rate reduction of 50 basis points instead of 100 basis points, as was decided. If the members of the MPC are as collegial as suggested, why the emphasis on their differences of opinion? Does this not lead to confusion and a greater lack of clarity? Surely there can only be one consensus.

In my opinion it is time for the MPC to review its communication strategy in the interest of clear communication and to counteract speculation. The main question is whether communication contributes to the effectiveness of monetary policy by moving short-term interest rates in the desired direction or by reducing uncertainty in the markets.

Reference