Optimal Communication is gold standard for central bankers

Mumbai: Optimal communication is the gold standard for all standard bankers, said the Reserve Bank of India (RBI) deputy governor Michael Patra on Friday.

In his opening remarks at the High-Level Policy Conference of central banks in the global South, organized by the RBI, Patra said that central banks must engage in constantly refining and upgrading this “soft skill” to make it effective. “The optimal level of communication remains the gold standard for all central bankers – too much can create a “signal extraction problem” while too little can keep the markets guessing,” said Patra.

Patra said that while the utility of forward guidance at very low policy rates is unambiguously proven, its efficacy at higher rates is questionable. “This is consistent with the asymmetric nature of the monetary policy cycle – the way down has a lower bound, but the way up is technically unconstrained by any upper bound. Under heightened uncertainty, discretion in forward guidance has increasingly gained legitimacy among major central banks. Empirical evidence in the Indian context suggests that forward guidance in a policy tightening cycle loses steam as the policy rate increases beyond a threshold.”

Giving RBI’s example, Patra said that since the adoption of flexible inflation targeting or FIT in 2016, the RBI monetary policy communication practices have largely mirrored global best practices in terms of publishing the analysis of evolving economic conditions, including outlooks for growth and inflation and the associated risks, and explaining the rationales for policy decisions, both in policy statements and through press conferences, which is followed by the release of the MPC minutes one fortnight after the policy announcement.

Unlike some advanced economy central banks, however, the RBI has generally refrained from providing explicit forward guidance on the policy rate, although it has provided both time- and state-contingent forward guidance during the COVID-19 pandemic. During the policy tightening cycle amidst heightened global uncertainty and overlapping shocks, the RBI was of the view that forward guidance itself could be a source of policy uncertainty undermining policy credibility.

Accordingly, it refrained from forward guidance in the policy tightening cycle. Nonetheless, the RBI has emphasised clarity in communication, while maintaining a balance between both high and low-frequency communication of monetary policy, he said.