Monetary policy is about robustness, not precision – panel

Setting policy rates is about keeping economies “robust” and not necessarily about hitting inflation targets precisely, panellists told the Central Banking London Meetings today (June 10).

The attendees included a deputy governor from a European national monetary authority and an official responsible for risk management at a west Asian central bank. The panel was moderated by a former deputy governor of a central bank in Europe.

The two panellists agreed that supply shocks had become larger, more frequent, more global and more structural. They also agreed that uncertainty was “no longer exceptional” and would have to be incorporated into decision-making frameworks.

Shocks for us are not just real events; it’s just the situation we’re living through

Official from a west Asia central bank

“Shocks for us are not just real events; it’s just the situation we’re living through,” the official from western Asia said. They explained that their central bank had introduced a “policy tranche”, a segment of reserves specifically accumulated and ring-fenced for unconventional policy interventions when normal policy transmissions broke down.

The official said scenario analysis was an “essential tool” for robust policy-making, and central banks would have to monitor all economic indicators equally to have a complete picture of how situations would play out. They noted that central banks had to catch the second-round effects of supply shocks early, as waiting would result in monetary authorities being too late to act.

They also highlighted their central bank’s novel approach to policy-making, which involved “minimising regret” across different scenarios rather than optimising a baseline. 

The European official said the options market was an important tool for understanding the distribution of inflation expectations. They highlighted the importance of central bank credibility and transparency, and said that traditional, precise forward guidance was no longer appropriate. They also celebrated how central banks had enhanced their toolkits over the past two years.

The official from the European institution emphasised that there was a risk of central banks overreacting. This, they said, could damage monetary authorities’ credibility, as cutting rates too quickly or reacting to the first signal could feed second-round effects.

The two policy-makers diverged on certain topics. The European official said the Iran shock would be less severe for the continent than the one that had taken place in 2022 following Russia’s full-scale invasion of Ukraine, as the European Union over the past four years had improved its energy mix and lessened its reliance on Russian gas. 

The official from western Asia said their own country’s proximity to Iran had fuelled geopolitical fears. They also emphasised the role of institutional frameworks and preparedness as a source of central bank credibility. 

The European deputy governor focused more on the limits of fiscal space to react to the Iran energy shock and emphasised the importance of well-targeted measures. They added that communication could be an “art” and a policy tool in and of itself.