Through the looking glass

“The quiet revolution” by Alan Blinder still has something to teach us. Although a little older, 2004, which in this world of whirlwind legislative change could render Blinder’s book obsolete Howard Davies says we should read it, and so read it we shall.

Central banks have been notoriously opaque, although of course things are changing. Consequently, in the footsteps of Lewis Carroll, we have been drawn through the looking glass of central banking. Many newspaper articles, papers and statements have repeatedly told us that transparency is good and so we've been persuaded that seeing what’s on the other side would indeed be beneficial. Why is that though? What benefits does this actually bring? What exactly waits for us on the other side of the looking glass.

Well, when it comes to central bank transparency Blinder comes to the rescue. He reminds us why both politically and economically transparency is a positive thing.

Politically he states that making the central bank more transparent enhances democratic accountability and also proves the quality of monetary policy. He does indeed remind us that a central bank is a democratic institution. It’s logical when you think about it - it’s there with the authority of the government and the government and the government are there with the power of the people. It is commonly created by an act of legislature or parliament, the ECB having been created by an international treaty is an exception to this rule. Interestingly, it’s not accountable to the government of any country. The improvement of monetary policy comes from the clarity of objectives which are set out when a bank is forced to be transparent.

Economically his argument centres around this. Central banks work their will by manipulating some very short-term interest rate, they are actually of little consequence but clear the market in which over night reserves are lent inter-bank. What does matter however is that these changes somehow influence the interest rates and asset prices that really matter (bank loan rates, corporate bond rates…) The links between these two however are sometimes quite loose. If then, through transparency we can strengthen these links the effects of monetary policy on the economy would be more predictable – and boom we’d have a more effective macroeconomic stabilizer.

What’s more interesting, and which is always fascinating about markets is the role of expectations. He states that actually since the policy of the central bank plays on expectations then by training the market about expectations would indeed help to increase the effectiveness of policy. And how can we achieve this, guess what, through transparency. By moving the hoop clearly and in a predictable way he feels the lion is more likely to jump where the central bank wants it to.

So, a few of Blinder’s thoughts, about why central banking transparency is beneficial. Why indeed going through the looking glass is so appealing and that hopefully the world that awaits us on the other side is not so crazy and topsy-turvey but in fact the reality we’re waiting for. Who know’s maybe Alice is looking in and we’ve been on the wrong side all along.

Blinder, Alan S., The Quiet Revolution, Yale University Press, 2004.