Communication matters

The U.S. Federal Reserve’s policymaker Federal Open Market Committee (FOMC) has met eight times a year since 1981. The United States was fighting with inflation and a poor economy at the time. Fed Chairman Paul Volcker, who came into office in 1979, took dramatic steps to tame inflation. He tightened money supply and raised the prime lending rate above 20 percent by the following year.

The market shook every time the FOMC met. In theory, it had to meet more than four times a year. But the number of meetings sometimes reached 19. Confusion was added to the market because it did not know when the next bombshell meeting would come. So the FOMC decided to fix the annual meeting frequency at eight.

Since then the FOMC became much more reasonable as it met twice each quarter. Economic data is related at the beginning of each quarter - January, April, July and October. The central bank could make policy rate decisions with more consistency when it reflects quarterly data instead of volatile monthly output, employment and inflation figures. Other central banks in the eurozone, Canada and Russia followed the U.S. Fed schedule. Japan and Britain will start similar timetables next year and the Bank of Korea too decided to hold policy meeting eight times instead of every month from 2017.

Monetary policy navigation is sometimes likened to alchemy - a protoscientific practice of purifying base metals like lead into nobler gold and silver - in the belief that good monetary maneuvering by the central bank could create wealth for the people.

The central bank sets the overnight bank lending rate that influences short-term and longer-term market rates. Its action has a decisive role in the economy as interest rates are fundamental when investing in stocks or borrowing money for business.

Because of its significant role, the central bank must maintain communication with the market. If the bank moves in the opposite direction after signaling a rate cut, the market would panic. People who invested on the expectation of lower rates would lose big. The central bank must therefore send clear messages to the market. It could ruin the economy if it doesn’t.

Since the beginning of the year, Fed Chair Janet Yellen had been pretty clear about lifting the base rate, which has been kept near zero percent since 2008. The action finally took place in December, but the market knew it was coming. The seven Fed board members and other state Federal Reserve governors also indicated the direction of policy during interviews and seminars. Hawkish Philadelphia Federal Reserve Bank President Charles Plosser, an outspoken critic of the central bank’s ultra-loose monetary policy, has been preaching the need for higher interest rates since late last year. New York Fed President William Dudley, who advocated for a monetary policy to stimulate the economy, joined the chorus in September and said the rate was expected to go up within the year.

The market stayed calm when the inevitability finally came on Dec. 16 with the fed rate raised to 0.25 percent from near zero percent for the first time in seven years. This was thanks to unwavering and consistent messaging to the market.

Korea’s policy rate is decided by seven monetary policy board members. The Bank of Korea governor and deputy are permanent members and the other five are named by the president through recommendations by the Korea Federation of Banks and the Korea Chamber of Commerce and Industry. The board members hardly say anything. It is the Bank of Korea governor who usually does all the talking. So the market only listens to the governor.

But not all governors are reliable. In July 2012, the board led by then-governor Kim Choong-soo cut the benchmark rate by 0.25 percentage point and surprised the market, because he had previously been suggesting no change in the rate. While keeping the rate unchanged in June, he said there was no talk of moving the rate from the current level. He had said the same thing in the previous month. Economic data over the two months changed little. Market players were confounded. One brokerage house analyst called the Bank of Korea the boy who cried wolf.

Bank of Korea chiefs make rate decisions about 48 times during their four-year tenures. One study showed a discrepancy ratio of 12.5 percent to 22.5 percent between the governor’s comments and market expectations in rate decisions. The governor cannot be 100 percent credible. Other monetary board members must help send a clearer picture and message on rate policy to the market. There is no regulation restricting board members from interviews or attending seminars. It is wrong for them to keep their mouths shut.

The Bank of Korea’s monetary policy committee drew sneers with its decision to emulate its U.S. counterpart to reduce the number of times it meets from 2017. How many times it holds meeting is not that important. What should matter is how it keeps in tune with the market.

Alchemists never succeeded in turning metal into gold. But their experiments brought great advances in science. The alchemists at the Bank of Korea cannot be expected to create fortunes for the people. But their efforts can at least minimize losses by enhancing transparency and predictability. That is one of the Bank of Korea’s main jobs: to communicate.

JoongAng Ilbo, Dec. 30, Page 32

The author is the head of the international economic team at the JoongAng Ilbo.

by Kim Jong-yoon