Over the last couple of weeks, the Fed and the ECB have released new economic forecasts following their regular schedule. According to the latest US central bank's projections:
The US economy is expected to grow by 2.2% in 2016, then to gradually revert to its 2% long run growth rate by 2018
The 2016 inflation rate is anticipated to be 1.2%, conveniently getting back to the long term annual rate of 2% by 2018
The March ECB’s forecasts can be summarized as follows:
Real GDP for the euro area is projected to grow by 1.4% in 2016, 1.7% in 2017 and 1.8% in 2018 as the economy benefits from increased momentum
Inflation is expected to be 0.1% for 2016, and to rise thereafter to 1.6% in 2018, at last!
The latest Bank of Japan’s forecasts are available here (1.5% GDP growth and 0.8% inflation for FY16, climbing to 1.8% for FY18, close to the 2% which has been so elusive for so long and is now apparently within reach).
Central banks’ projections are a big deal. First, central banks’ staffs are assumed to have access to the best information available on the state of their economy. Therefore, their projections should be more reliable than that from other sources. Second, unlike most economists from profit-seeking organizations, they are deemed to be bias-free. Let us test both arguments.
A 2014 Fed paper looked into the accuracy of central banks’ forecasts over 2000-12. It determined that GDP growth was systematically overestimated, with the difference being larger during the crisis (2008-12), while predicted inflation was lower than realized. The authors note that central banks typically “ignored or failed to take fully account of the powerful adverse feedback loops between the financial system and the real economy.” The paper concludes that the Fed and ECB forecasts were no better than outside forecasters. So much for higher reliability.
Are central banks at least bias-free? Most likely not. As noted by Axel Weber, former President of the Deutsche Bundesbank, in a 2009 speech, “the publication of [central banks’] forecasts helps to anchor the expectations of firms and households, thereby making the central bank more effective in fulfilling its objective.” Central banks’ incentive to shape expectations are laid bare, with a free license to practice propaganda.
Propaganda may have a negative connotation but is not necessarily evil. Edwards Bernays, a Freud nephew, stated in his book entitled “Propaganda” (1928) that “the conscious and intelligent manipulation of the organized habits and opinions of the masses is an important element in democratic society.” A few decades later, in a formidable book entitled “The Formation of Men’s Attitudes”(1965), Jacques Ellul insists upon the mutual need for propaganda from individuals and governing institutions alike in mass societies:
Uprooted, i.e. “no longer geographically attached to a fixed place or historically to his ancestry”, the “ordinary man” craves propaganda. Adherence to it creates a sense of belonging as he looks for the “collective signals which integrate his actions into the complete mechanism.” In a complex world, propaganda also brings some welcome coherence and a value framework.
People’s opinions and behaviors fluctuate too often to allow for the implementation of consistent policies. “As the government cannot follow opinion, opinions must follow the government”. Public institutions must therefore look through volatile behaviors and seek to foster stability through skillful communication (in line their democratically set mandate)
If this was right fifty years ago, it has to be even more so today. In this context, associating propaganda with central banks’ communication is not heretic. Economic actors, including investors, are the propagandees. They do welcome the establishment of an economic framework which empowers them to make long term investment decisions as part of a collective movement driven by competitive forces; Central banks, an extension of government, act as the propagandists. They must discount the erratic sentiment of economic actors to set effective monetary policies which can be justified by forecasts. There would be no happy propagandists without happy propagandees.
To retain their power as propagandists, central banks ought to remain credible, though. The Bank of Japan has been dangerously flirting with a lack of credibility with its blind belief in a 2% inflation rate; The ECB’s economic forecasts a year ago were too evidently aggressive, especially on the inflation front;3 The Fed has also been taking too positive a view of its economy in recent quarters, with a perspective on future rate hikes consistently disconnected from that of the market. As a result, their collective power has been questioned.
At the same time, the bar for effective propaganda has been raised significantly, especially as central banks now have to actively manage financial markets’ sentiment given a new appreciation for the powerful feedback loop between the markets and macro-economics. To extract the world from self-defeating short-termism, higher quality central banks propaganda is required.