CAN CENTRAL BANKS TALK TOO MUCH?

Because central banks inevitably make mistakes in their forecasts, they should only disseminate information about macroeconomic fundamentals to a select audience. That is one of the findings of research by Dr Camille Cornand and Professor Frank Heinemann, published in the April 2008 issue of The Economic Journal. They conclude:

‘Our results give a rationale for the common practice of central banks to release partially public information in addition to official publications.’

‘Information with low precision should be partially withheld from the public. Information of high precision should always be released with full publicity. But no information should be entirely withheld from markets.’

‘Partial publicity can be achieved when central bankers deliver speeches or invite a small group of journalists. Announcements in such environments are less widely reported than formal announcements or require more time to penetrate the whole community.’

While practitioners in central banks and international institutions agree on the desirability of informative announcements and promote higher transparency on the grounds that any information is valuable to markets, recent research has argued that public announcements may destabilise markets by generating some over-reaction.

Financial markets and macroeconomic environments are often characterised by ‘positive externalities’. For example, during speculative episodes, it is rewarding for a trader to attack a currency or run a bank if others decide to do so.

In these environments, public announcements serve as focal points for traders in predicting others’ beliefs and, therefore, affect the behaviour of market participants more than is justified by their informational content. If public announcements are inaccurate, private actions are drawn away from the fundamental value.

Public information is a double-edged instrument: it conveys valuable information, but the desire to coordinate leads market participants to condition their actions stronger on public announcements than is ideal. Stephen Morris and Hyun Song Shin argue that ‘noisy’ public announcements may be detrimental and conclude that central banks should commit to withholding relevant information or deliberately reduce its precision.

Cornand and Heinemann challenge this conclusion by distinguishing two components of transparency: precision of information; and degree of publicity.

The degree of publicity is the proportion of people who receive a message from the central bank. A message of limited publicity is always superior to withholding information or reducing the precision of announcements. Indeed, all information is valuable to the extent that it helps in predicting the state of the world. A limited degree of publicity reduces incentives to exaggerate the weight on public signals, because rational traders know that other traders do not share this information.

On the other hand, a partially public announcement improves the quality of decisions by those market participants who receive this signal. Thereby, limiting publicity combines the positive effects of valuable information for those who get it with a confinement of its threats by limiting the number of receivers.

The higher the precision of public signals, the lower is the probability that an exaggerated weight reduces welfare. Hence, full publicity is optimal if public signals are sufficiently more precise than private information. But even if authorities can only provide rather imprecise signals, it is better for them to provide this information to some market participants than withholding their knowledge.

Any means of information dissemination that reduce the degree of common knowledge has the same effect as a limited degree of publicity. These results imply that it may be more efficient to disseminate imprecise messages in communities or through media that reach only a part of all traders.

ENDS

Notes for editors: ‘Optimal Degree of Public Information Dissemination’ by Camille Cornand and Frank Heinemann is published in the April 2008 issue of The Economic Journal.

Camille Cornand is research fellow of the Centre National de la Recherche Scientifique, Bureau d’Economie Théorique et Appliquée in Strasbourg. Frank Heinemann is professor at the Technische Universität Berlin.

For further information:contact Camille Cornand on +33 607 556 170 (email: cornand@cournot.u-strasbg.fr); or Frank Heinemann on +49 303 142 2002 (email: f.heinemann@ww.tu-berlin.de); or Romesh Vaitilingam on 07768 661095 (email: romesh@compuserve.com).