Black box or Pandora’s box? Central bankers face dilemma

By Mirela Roman

This “like-no-other” Covid-19 pandemic is clearly a dangerously unique event, with ongoing severe economic and social consequences all around the globe. Nassim Taleb has famously described the Black Swan and more recently, BIS researchers pointed to the Green Swan in reference to the impact of climate change.

But the Covid-19 Swan is quite a combination of colours. It is an ongoing emergency situation, with fear often overcoming hope while anxiety heightens amid a decline in living standards.

As Bill Gates was saying earlier this year, experts have warned about pandemics for years, so the Covid-19 crisis was virtually inevitable.

This is despite the fact that the world was obviously unprepared and, more worryingly, reluctant to test such grim scenarios in most of the business continuity plans all across the globe.

Unlike in 2008 though, this time authorities – health, monetary, fiscal and macroprudential – came up with relatively swift combined policy responses.

As people get bombarded with data, information, bad news and stories, they ultimately look for competence, despite a first impulse to follow sensationalist, but often misleading advice.

However, competition for attention online is rather fierce – just look at all the misinformation about the causes and consequences of Covid-19 we have witnessed since the start of the pandemic.

Little wonder, then, that public authorities — central banks included — struggle to get their message across.

Throughout history, in their quest to reach the general public, shape expectations, smooth transmission mechanisms and achieve price stability objectives, central bankers have constantly adapted their wordings, especially at crucial inflexion points.

They have been shifting from Alan Greenspan’s era of “constructive ambiguity” to Ben Bernanke’s reshaped “yes, we can!” slogan aimed at calming sentiment in the aftermath of the 2008 crisis and to Mario Draghi’s “whatever it takes” mantra at the height of the euro crisis in 2012.

As the Covid-19 outbreak reached Europe, Cristine Lagarde’s “no limits” on the commitments to preserve the euro was an even more persuasive phrase than Draghi’s daring 2012 promise.

European Central Bank president Christine Lagarde. Source: IMF

And in recent months, central banks’ swift measures — rate cuts, repo lines, ensuring cash, liquidity and functional payments, reloaded forward guidance and, last but not least safety for their own staff aligned in the front – have spoken louder than their words.

Lessons learned: the 2008 financial crisis

By opening the 2008 moment Black Box, central bankers proved they learned the lessons from those times and quickly adjusted their tactics and strategies.

Moreover, their efforts to resonate more with the wider audiences may be captured in Jerome Powell’s pledge that the FED was working to help them or in the explanations that this time was different because banks were now part of the solution, not the trigger of the crisis by Andrea Enria, head of the SSM, the ECB’s supervision arm.

While price stability remains the overriding goal stipulated by their laws (or the Treaty in case of the ECB), what this actually means, how it is measured and how it is achieved is quite flexible and up to most of the central banks across the world to decide: it’s part of their strategy reviews.

And the recent drive to listen to and involve their stakeholders into those assessments, at least for the big names (ECB, Bank of Canada, the dual-mandated Fed or the Reserve Bank of New Zealand — the first central bank to adopt inflation targeting), is worthy of notice.

Exploring what externalities are not included in that price stability definition is “not an easy game in town” as Christine Lagarde recently said.

Nevertheless, she reiterated very plainly that the ECB cannot be a “substitute for the fiscal authorities, the European Parliament or other democratic institutions” in the eurozone member states.

Central bankers were in the front line of defence again, this time next to health workers and government authorities, which became more involved that in previous crises to address this extremely serious one

Looking back, central banks across the globe have proven to be quite innovative in the past decade in both their toolkit as well as their approach of communicating with the public by pursuing a more direct and persuasive narrative and listening to audiences beyond their traditional watchers (markets and the media).

Bold steps and new instruments – quantitative easing, forward guidance, macroprudential kits – were put in place, while standard tools like the monetary policy interest rate went into the negative territory.

However, as international institutions via their key voices – Bank of International Settlements general manager Agustín Carstens or IMF managing director Kristalina Georgieva – repeatedly warned, the solution is not solely in the central banks’ fire-power.

Others in the policy mix – the fiscal, macroprudential and structural policies – were due to take the stage, and there’s no time to waste.

On the fiscal side, even though recent measures came sooner this time compared to the slow reactions back in 2008, innovation has somehow lagged behind, and has mostly been related to the spending and debt management side.

Prevention is better than cure

While opening the public purse at a societal inflexion point is well justified, there is too little focus on the flip side of the coin, namely revenues (tax reforms).

This is the one which, in the medium and long run, will lay the ground for well-targeted, greener investments in order to achieve a healthier, sustainable and more inclusive economic recovery. Remember that treatment is always more expensive than prevention.

Moreover, any shift in the fiscal paradigm must also be accompanied by the long-awaited and profound structural changes that deserve more than words from the governments and the private sector.

Calls from all across the board, including central bankers, point to the fact that the time to act may be up in a bid to truly address the present challenges so that they would leave as few scars as possible.

Looking forward, new avenues for central banks’ policies, some of which already make conservatives very nervous, have yet to be tested.

Among these: helicopter money and digital currencies, but also incorporating sustainability (climate/social) in how central banks operate not only their own framework or alongside their financial stability functions, but also in the more traditional areas such as monetary policy and cash issuance.

It’s fair to say that without price stability any sustainability goal has little scope, but this may also be true the other way around.

As monetary policy affects all sectors of the economy and all sorts of public, there’s a justified need to enlarge its rather narrow horizon, to take a thorough look at the transmission mechanisms and tools with impact beyond the financial arena, and consider the new, material challenges posed by the present age of uncertainty: climate change, digitalisation, inequality and inclusion.

“It’s our duty to open that box a bit more,” Lagarde said during a recent ECB Listening Event. “While climate is imperative, people are the goal,” she rightly concluded.

But we need to think hard what kind of a box are we going to open: is it the black box, which would enable deep analysis of reactions during various crises and indicate the necessary reviews of some mechanisms? Or is it just Pandora’s box?

If the latter, we have to make sure that Hope gets out of the box and into our hearts, to help us cope with the lockdowns, fears and uncertainty of the pandemic.

Mirela Roman is an expert in monetary policy communication, having worked with central banks as a Reuters journalist and as a communications director in a central bank.