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A senior European Central Bank official said publishing its policymakers’ interest rate forecasts – similar to the US Federal Reserve’s “dot plot” – could help plug gaps in its communication and combat market volatility.
Isabel Schnabel, one of the most influential voices on the ECB board, said in a speech on Wednesday that the central bank could benefit from adopting some of the ideas raised by the former Fed president, Ben Bernanke, in his recent review of the Bank of England’s forecasting processes. .
“Some of the points he [Bernanke] raised could also be relevant for the ECB,” Schnabel said. “One area for consideration concerns whether policymakers’ views on the expected future path of short-term interest rates should be made more transparent, similar to the ‘dot plot’ used by the Federal Reserve .”
His comments – the first time an ECB leader has suggested such a change – show how central bankers are questioning the fundamental way they set monetary policy after widespread criticism that they have were too slow to react when inflation started to rise in 2021.
Schnabel said it would “carry risks” if central banks returned to the way they operated before the Covid-19 pandemic sowed the seeds of the biggest price surge in a generation.
The standard process of communicating their plans through adjustments to a central inflation forecast “may need a deeper overhaul, even as inflation approaches levels consistent with price stability,” she said.
Since their introduction in 2012, dot plots have become one of the Fed’s most important communications tools, allowing its policymakers to tell markets what they plan to do with interest rates in months to come.
Bernanke, who pioneered the dot plot at the Fed, stopped short of recommending that the BoE follow suit – despite widespread support for the idea among economists. But he said it “should be on the table” for future debate after presenting the results of his review last week.
The ECB, led by President Christine Lagarde, publishes economic forecasts based on market expectations for rates, but it gives little guidance on what members of its governing council expect it to do. what happens to key rates in the future. An official record of council members’ discussions, released four weeks after each policy meeting, is anonymized and lacking in detail.
Schnabel said releasing individual board members’ rate forecasts “could help signal the risks that committee members attach to the base case developed by staff.”
She added: “A dot chart can therefore help convey uncertainty about the future course of the economy and simultaneously provide greater clarity on the future course of interest rates by policymakers, which which could potentially help combat excessive market volatility. »
The theory behind the dot plot is that determining the rate path expected by policymakers will allow long-term borrowing costs to adjust to the Fed’s plans, meaning monetary policy can have more impact on economic conditions.
However, Fed observers do not always agree with the projections. Earlier this year, the dots indicated that U.S. policymakers would need to cut rates three times during 2024.
Markets, however, priced in six cuts and only adjusted their expectations after data showed the U.S. economy – and inflation – remained stronger than the Fed or investors expected.
Schnabel said a potential “downside” of publishing rate forecasts is that they could “excessively condition market prices, thereby effectively reducing their information content”, pointing to research showing they have lowered yields. long-term growth by 1.3 percentage points over the past decade. .
She added that the ECB could also consider publishing more details of the council’s views as part of its use of alternative scenarios to illustrate the different paths inflation could take.
