Central banks can have a better chance at achieving a soft landing by improving their messaging, the International Monetary Fund has said.
The prospect of high inflation becoming embedded in the economy has proved a challenge for global central banks, but expectations about future inflation play a key role in managing it, the IMF said in a newly released chapter of its World Economic Outlook.
“In other words, the expectations channel is key to the elusive 'soft landing' of bringing the inflation rate down to target without a recession,” the IMF wrote.
The IMF paper established two types of learners when it comes to central bank messaging: backward-looking and forward-looking.
Backward-looking learners view on future price changes based on previous inflation experiences when central banks communicate poorly. Forward-looking learners, meanwhile, form opinions on inflation based on a wider selection of information relevant to future economic conditions.
“Monetary policymakers benefit from having a clear understanding of the nature of expectations processes at play in their economies,” the IMF found.
The organisation added that improving monetary policy frameworks and communication strategies can also increase the share of forward-looking learners, thus boosting the effectiveness of monetary policy decisions.
The Federal Reserve has been one of a handful of central banks to reshape its communications strategy. The US central bank recently launched a new Instagram platform to reach a larger audience and Fed Chairman Jerome Powell hosted a town hall with educators last week.
Mr Powell noted the importance of the public in the effectiveness of its monetary policy decisions. Part of the reason the Fed releases its economic projections is to influence spending decisions in the near term, but “that will only be the case” if people understand how the central bank's decisions affect their finances, he said.
He also said the US central bank has become more transparent in recent years, pointing to traders knowing what interest rate decisions the Fed will make before they are announced, meaning markets can react and affect the economy sooner.
The Fed has also been consistent in its messaging on raising interest rates, which now sit between 5.25 per cent and 5.50 per cent. Fed officials projected one more quarter-rate increase this year, although a majority of traders expect rates will be held steady at the current target range.
Now, the Fed is in a different stage of its inflation battle. After moving rapidly to raise rates and curb inflation, Mr Powell has said policymakers are now in a position to act “carefully” – a word he mentioned more than a dozen times following the September 19-20 meeting.
By contrast, the Bank of England's communication has been murky. The UK central bank in February signalled rates were at a near-peak level of 4 per cent. There were also hopes that the Bank of England was near the level of keeping rates steady after raising them to 4.5 per cent in May.
The current interest rate level in the UK today is 5.25 per cent.
Even with the UK bank's recent communication struggles, the IMF found that messaging is better in advanced economies than in emerging markets and developing countries.
The IMF noted Brazil's recent decision to adopt a continuous 3 per cent target inflation rate from 2025 as a way of reducing confusion and enhancing the effectiveness of the central bank's policy.
The central banks of Pakistan and Uruguay were also noted for announcing their monetary policy meeting calendar in advance.
“Both inflation expectations and inflation would decline modestly more quickly with improvements in monetary policy frameworks and communication – such as simpler and more regular messaging and better targeting of audiences – that boost the share of forward-looking learners in the economy,” IMF researchers said.
“However, such measures may take time or be more difficult to implement than tighter cyclical policies, which come with much higher costs in terms of slowing growth.”