Imagine if central bankers similarly were required to tell us, in a clear, credible, and comprehensible way, how they will follow a systematic strategy to use their knowledge, skills, and policy instruments to react to the economic data they will face. Many observers have argued that this would substantially improve monetary policy by eliminating unnecessary uncertainty associated with the difficulty of forecasting a central bank’s reaction function—the mapping from publicly observable data to publicly observable actions by the central bank (Calomiris 2018).
Dincer, Eichengreen, and Geraats (2019) identify self‐discipline, predictability, and credibility as the fruits of central bank transparency. Central bankers following a disclosed systematic strategy of monetary policy clearly would achieve the highest marks on all three dimensions. They would display perfect self‐discipline by forcing themselves as a group to formulate a strategy to guide their actions, as economists have shown is highly desirable (e.g., Kydland and Prescott 1977). Because their actions would be predictable reactions to changing circumstances, they would create no avoidable uncertainty. They would enjoy perfect credibility, proving with each relevant data release and every action that they were reliable public servants.
Of course, there would still be the unavoidable long‐term uncertainty associated with the necessary changes over time in the central bank’s agreed reaction function. But, with the exception of reactions to severe crises, those changes would be announced in advance.1 The unpredictability arising from changes in an evolving framework for the central bank’s reaction function is necessary because the structure of the economy is not static, because frameworks make use of different tools under different circumstances (e.g., at very low interest rates, quantitative easing [QE] actions may replace interest rate actions), and because humans’ understanding of that structure is always imperfect.
Unfortunately, however, many commentators on central bank transparency take too narrow a view of the topic, and consequently, they fail to consider as part of transparency, the most important part: formulating and disclosing the strategy for central bank policy. Central bankers often receive very high grades for “transparency” despite the absence of any articulation of a systematic framework. Dincer, Eichengreen, and Geraats (2019) offer a careful, comprehensive, and valuable cross‐country comparison of central banks’ practices, and their measure takes into account not only data about central banks’ speeches and minutes, but also the extent to which the central bank provides useful information about its policy intentions. Their measure of transparency highlights important differences across countries. But their definition, which scores the Fed as one of the most transparent central banks in the world (exceeded only by two countries), may not penalize central bankers sufficiently for failing to agree upon and announce a systematic framework for policy. Announcing a specific policy framework is one of the criteria in their scoring model, but they may give too much weight to other factors—whether central bankers give public speeches and testimony, disclose the minutes of their meetings fully and promptly, and share some of their forecasting opinions with the public.
Although it is desirable for central bankers to disclose the content of their speeches, testimony, committee deliberations, and forecasts to the public, the act of providing those words and facts to the public may not be very useful if a central bank avoids clearly stating a systematic framework for policy. True transparency requires central banks to provide understandable and reliable information to the public that makes it possible for the public and their delegated representatives to actually hold central bankers accountable for their statements and behavior, and that is not possible in the absence of a detailed, quantitative description of central bank strategy, embodied in a reaction function.
Meltzer (2014) provides a brief summary of the history of policy errors by the Fed, and shows how adherence to systematic policy would have prevented many of them. Systematic policy should not be seen as a constraint on what the Fed is able to do, either in the long run or the short run (Meltzer, along with all serious advocates of systematic policy, understood the necessity of revisions in the framework over time, and the desirability of short‐run deviations from it during financial crises). Meltzer argued, however, that the point of systematic policy was to make the Fed accountable. Meltzer recognized that transparency only in the sense of mechanical disclosure of facts, without a commitment to systematic policy, is incapable of producing accountability.
Without a systematic policy framework, neither Congress (which is responsible for overseeing the Fed under Article I, Section 8, of the Constitution) nor the public can exert any effective oversight of the Fed. Requiring the Fed to announce a systematic policy allows others to evaluate that procedure, to verify whether the Fed is following it, and to ask specific questions about observable deviations. Without a systematic policy, questions to Fed officials during congressional hearings produce vague and lengthy responses, a form of double talk that Fed officials are expert at delivering, precisely because doing so avoids accountability. Alan Greenspan is said to have once quipped, “If you understood me, then I misspoke.” The joke is funny for a reason.
Fed governors are also expert at orchestrating their recorded Federal Open Market Committee (FOMC) deliberations to ensure that potentially embarrassing real disagreements are negotiated outside the meeting rather than reflected in conflicting votes. This has led to a severe secular decline in recent years in the public FOMC voting disagreements among Fed governors (Thornton and Wheelock 2014). From 1957 to 2013, Federal Reserve bank presidents dissented 241 times, and Fed governors dissented 208, but from 1994 to 2013, governors effectively stopped dissenting (presidents account for 72 of 76 dissents during that time frame). Presidents also tend to dissent much more when they are in favor of tighter policy—78 percent of their dissents were for tighter policy, in contrast to governors for whom only 28 percent of dissents were for tighter policy.
Similarly, although Hansen, McMahon, and Prat’s (2018) analysis of FOMC transcripts finds that greater disclosure of Fed discussions are helpful in encouraging FOMC members to inform themselves more, they also confirm earlier findings that the greater transparency produced by the publication of FOMC minutes promotes greater apparent conformity of expressed opinions, as policymakers are less willing to express differences publicly. Cannon (2015) shows that this change has been particularly pronounced for Fed governors. These findings confirm the early research by Meade and Stasavage (2008), who find that the decision to disclose FOMC transcripts reduced dissent and encouraged greater use of prepared comments rather than unscripted ones. Acosta (2015) also finds evidence of greater conformity in word choice after the increase in disclosure. These findings reinforce the distinction between disclosure and true transparency. Indeed, it appears that, in the absence of an articulation of systematic policy framework, greater disclosure may have made the disclosed discussions less meaningful to the public.
What about the Fed’s commitment to a long‐run 2 percent inflation target? What effect does that have on improving transparency? The 2 percent commitment was a major step in the direction of making policy goals clear, but it said little about short‐run strategy to achieve that goal. And even that commitment is now uncertain. The 2 percent inflation goal is not a matter of law, merely of Fed officials’ voluntary commitment, and the Fed recently decided to reconsider that goal (see Thomson Reuters 2018). When your long‐run goals are open to revision, and your short‐term strategy is either secret or nonexistent, how can you be considered a model of self‐discipline, predictability, and credibility?
But perhaps this is all about to change. What if central bankers found it in their own interest to create and announce a systematic framework for monetary policy? Why would that happen? Returning to the “True Lies” analogy, if central bankers knew that they would be forced to speak under the influence of truth serum, then they might decide that it is in their best interest to adopt and announce a systematic monetary policy. Central bankers who know that their thoughts are being revealed publicly—and then analyzed systematically—would no longer be able to use the absence of a systematic framework to avoid accountability for clear mistakes in their thinking, or for duplicity or opacity in their policy releases, or inconsistency over time in their reactions to information. Avoiding a systematic policy, therefore, would cease to be attractive to Fed officials as a way to skirt accountability. Adopting a systematic approach to monetary policy that could be defended on its merits would allow them to avoid the embarrassment of revealed errors, dishonesty, and inconsistency.2
But how, you may be wondering, do we get them to take the truth serum? Maybe we don’t have to. Instead, we can subject their words to natural language processing (NLP). Like mind reading and lie detecting, NLP allows researchers to extract the underlying meanings of word flow, even when they have been shrouded by vague or misleading statements by the author of those words. Because it subjects the entirety of central bank communications to in‐depth, real‐time analysis, NLP shines new light on what central bankers know, believe, and do, and that new light will make it easier for the public to hold central bankers to account for missing, withholding, or distorting information, and this will provide a strong incentive for them to construct a systematic, transparent approach to policy.