Central banks regularly communicate about monetary policy. They use various channels, such as annual reports, press conferences and interviews. By communicating frequently, monetary policymakers seek to be transparent about their policy. They explain their decisions and may give an indication of future steps. This enhances the public’s understanding of what they may expect from the central bank.
Not only how often, but also how clearly, they communicate is important. If a central bank communicates frequently, but in a vague manner, the public may have difficulty processing the information. Research by DNB on communication by the US central bank shows that plain language is indeed effective. The clearer the Federal Reserve’s communication, the smaller the price fluctuations in financial markets.
What is plain language?
Clarity can be measured by looking at the structure of a text. Various criteria have been developed within psychology and linguistics. A measure used in the research is based simply on the length of words and sentences in a text. The intuition is that long sentences and words make a text difficult to understand. This measure expresses the number of years schooling a person needs to adequately understand a text. A higher value hence means less clarity: more effort is needed to fathom the message.
How clear was the Federal Reserve?
Figure 1 shows the measure for the clarity of statements by Federal Reserve chairmen: Paul Volcker, Alan Greenspan and Ben Bernanke. They made these statements during the Humphrey-Hawkins hearings in the US Congress between 1980 and 2009. These hearings, named after two US politicians, have been an important means of communication for the US central bank since the late 1970s. During the Humphrey-Hawkins hearings, the chairman gives an overview of economic expectations and their possible implications for monetary policy. The clarity of these statements differed considerably. Fourteen years schooling was in some cases enough to adequately understand the chairman’s statements, while in others sixteen was required. The clarity of communication has notably declined since the start of the financial crisis in 2007: the required number of years schooling increased sharply from around fifteen to close on seventeen.