Nobel Prize winner Ben Bernanke believes central banks should provide alternative economic forecasts and explain how they might react if those scenarios were to happen

Former US Federal Reserve Chairman and Nobel Prize-winning economist Ben Bernanke says central banks should provide alternative economic forecasts and hypothetical policy responses. 

Speaking at the Reserve Bank of New Zealand’s monetary policy conference on Thursday, Bernanke said communications should put greater emphasis on uncertainty when providing guidance.

He said the US Federal Reserve had focused the public's attention on its “most likely” forecast, which suggested inflation was transitory.

“When the inflation proved not to be transitory, it hurt the Fed's credibility. And more seriously, the public was not well informed in advance about what the Fed's response would be once the baseline forecast proved wrong,” he said. 

It would have been better for the policymakers to say the baseline forecast was transitory, but also explain other possible outcomes and the policy response those scenarios would trigger.

"Being more explicit about providing alternative economic scenarios and clarifying how policy would react in each case, could possibly have helped divert the 2013 taper tantrum,” he said. 

The taper tantrum refers to the market turmoil that occurred under Bernanke when the US Federal Reserve signaled it might slow bond-buying, causing interest rates to spike and asset sell-offs.

Bernanke said providing the market with alternative economic scenarios and an approximate policy response would improve credibility and transparency.

U-turn tantrum

The RBNZ took its own credibility hit in May last year when it signaled interest rate hikes, only to launch an aggressive cutting cycle 12 weeks later. Analysts called it a “policy U-turn”, something Governor Adrian Orr fiercely denied. 

Deputy Governor Christian Hawkesby attempted to explain it in an interview with Interest.co.nz, claiming the Monetary Policy Committee had discussed “big uncertainties” to the forecast. 

He argued market commentators had focused too much on the forward projections and hadn’t paid enough attention to the discussion of risks. 

“There's something quite peculiar that happens when someone sees a line on a chart, or they see a number in a table, it has this sense of being real and factual,” he said.

Hawkesby's argument was not very strong, as the official record of the meeting only discussed uncertainty in very broad terms and never contemplated rate cuts. Whatever other scenarios were considered behind closed doors were not shared with the public.

But after that meeting there was some talk about whether the bank should present its interest rate projections differently, with chief economist Paul Conway even raising the idea of different scenarios. 

While there was no opportunity for Interest.co.nz to interview Bernanke, it seems like he would be sympathetic to the RBNZ publishing more than one set of forecasts and possible Official Cash Rate outcomes. 

"I think it is important to pick just a few [alternative scenarios] and try to find ones that, for one reason or another, are relevant to the current situation. Part of this is just getting people to understand that we don't know, for the next three years, what the rate is going to be. We have different contingent strategies depending on what happens," he said in his speech

Hawkesby on Orr 

The monetary policy conference was opened by Hawkesby, who was filling in for Adrian Orr who walked off the job without notice the day prior. 

He said the former Governor of the Bank of England, Mervyn King, used to say that monetary policy could be compared to running a marathon in laps around a short athletics track. 

“So it's a long journey, but my view is, if that if you want to step out of the track and take a break, then what better time to do it than when inflation is right at the middle of the target range, the economy is on the up, and the financial system is in great shape”.

“I'm delighted that Adrian's been able to finish on that high,” he said.