From Central Banking to Central Planning? Forward Guidance, Quantitative Easing, and the Politics of Expectation Management
The recent escalation of central banks’ efforts to manage private sector expectations has introduced a form of central (bank) planning that amounts to a significant modification of the nature of state agency in the field of monetary governance. The pre-crisis policy paradigm targeted only short-term interest rates, regarding the long-term rate as a market-determined barometer for private sector expectations of the future. By contrast, the twin-policies of forward guidance and quantitative easing aim at turning the long-term rate into a policy variable. Concentrating on the European Central Bank, the paper draws on interviews with both central bank staff and financial market participants to study the effects of these policies on the dynamics of expectation formation in the euro area. Although only the latest steps in the gradual extension of the temporal reach of monetary governance, forward guidance and quantitative easing have brought a latent tension inside the communicative apparatus of expectation management to the surface – the question of whether market participants perceive central bank forecasts as impartial predictions or as rhetorical devices used to manipulate market expectations. Recent policy innovations may have tipped the balance in favour of the latter interpretation.
Extended summary
In the wake of the global financial crisis of 2008/09, central banks largely succeeded in staving off financial meltdown and in bringing the financial system back from the brink, thus demonstrating the enormous sway they hold over the economy. Subsequently, however, the picture changed. With conventional monetary policy stuck at the ‘zero lower bound’, the deployment of ever more drastic ‘unconventional’ measures to stimulate economic growth has revealed the limits of central bank power. Strikingly, all leading central banks ended up adopting the same combination of policies – ‘forward guidance’ and ‘quantitative easing’ (QE). This paper constitutes an attempt to come to analytical terms with these two dominant features of the post-2008 landscape of central banking – the thin red line between power and impotence, and the stunning uniformity of central banks’ policy responses to the crisis. Three main sections deal with three successive questions.
1. How can central bank agency be conceptualised? While the conceptualisation of monetary governance as an apparatus for the management of expectations – which today is widely accepted among economists, sociologists, and practitioners – is correct, in analytical terms it constitutes a point of departure rather than a result or an explanation. Taking seriously the gap between the “very limited and crude tools” and the “very big job” of the central bank (Hall 2008: 198) means to account for the ways in which interest rate signals, which the central bank controls, are transmitted through the economy to affect long-term expectations, and thus the macroeconomic aggregates of investment, output, employment, and inflation. This first section reviews the development of the transmission mechanism of monetary policy – and of its theoretical rationalization – since the 1980s, placing particular emphasis on the co-evolution of central bank practice and the structure of the financial system. Questioning the standard definition of central bank credibility as ‘honesty’ or ‘dependability’, I argue that the gradual expansion of expectation management has gone hand in hand with attempts to bolster the ‘epistemic authority’ of central banks, defined as the degree to which market actors are ready to build their own expectations on the central bank’s models and forecasts.
2. How does the near-universal adoption of forward guidance and QE relate to the evolution of expectation management since the 1980s? The section begins by summarising the key features of forward guidance and QE as adopted by the ‘big four’ central banks (Fed, ECB, BoE, BoJ). Building on the preceding discussion, this section shows that forward guidance and QE represent a logical continuation of the long-standing trend of guiding private sector expectations of the future. At the same time, however, this most recent extension of the apparatus of expectation management has arguably pushed it into qualitatively new territory. As recently as 2008, the ECB (2008: 79) declared that it “recognises that developments in longer-term money market interest rates reflect market forces and that this market segment is beyond the ECB’s direct control”. This idea of leaving the determination of longer-term rates to the market, thus minimising the central bank’s own (distorting) influence, has long been a key element of the paradigm of inflation targeting. By extending their reach to the far end of the yield curve, central banks have crossed the boundary, established and fortified by their own discourse, between central banking and central planning.
3. What, in turn, have been the effects of forward guidance and QE on central bank agency? Focusing on the case of the ECB, the final section investigates the effects of unconventional policies on central bank agency. Drawing on data from interviews with market participants from various sectors of the financial system, I show that doubts over both aspects of the ECB’s credibility have made visible the “politics of expecations” (Beckert 2014) previously hidden inside the seemingly consensual apparatus of expectation management. Firstly, the ECB’s epistemic authority is being challenged on the grounds that forward guidance and QE have moved the temporal horizon of expectation management beyond the bounds of even the central bank’s forecasting ability. Secondly, these epistemic uncertainties fuel doubts about the ECB’s ‘honesty and dependability’ as market participants question the sincerity of central bank forecasts, suspecting policy makers of using forecasts as rhetorical devices. The paper concludes by cautioning against taking such statements at face value. The tension they bring to the surface has always had a latent presence in the apparatus of monetary expectation management. Invisible under the benign conditions of the ‘Great Moderation’, the politics of expectations currently manifests itself in a new element of distrust – even antagonism – in the relationship between the ECB and its financial market audience.