In 1989, journalist and author William Greider wrote a book, Secrets of the Temple, which was a rather ill-informed attack on the US Federal Reserve under Paul Volcker. The book was about the years when Volcker pushed interest rates sky-high and the US economy went through a painful recession in the early 1980s. But the pain of the Volcker years helped squeeze inflation out of the global economy and created the base for the subsequent long boom.
Greider’s main concern was not the economics underlying the Volcker squeeze. He portrayed the US central bank as a temple—secretive and powerful. The idea that central bankers constitute a priesthood that lords it over the rest of us is of an old vintage. With it goes the attendant belief that central bankers operate in some sort of bubble, cut off from what ordinary citizens and companies feel about the economy.
This is a blatantly unfair view of contemporary central banking. Increasingly, the monetary mandarins are trying to plug into the chatter of the streets and the assembly lines to understand the future, or rather our expectations about it.
Most economic data is historical—it shows us what happened in the past week, month, quarter, year. But producers, consumers and investors make decisions based on what they expect in the future. How strong will the demand for my products be? Is inflation going to rise or fall? Should I sell my shares and buy a house? These decisions eventually impact the economy. Central bankers thus have to try and measure expectations. One way they do it is through sample surveys.
It is good that the Reserve Bank of India (RBI), too, is now using surveys to gauge expectations. Since September 2005, the bank has been quizzing 5,000 household respondents about their expectations about future inflation. The initial surveys asked questions on expectations over three months and a year on four issues—the general price level, food prices, house rent and the price of services. Other questions were added on later, covering expectations on prices of non-food products and consumer durables.
“Given the forward-looking nature of monetary operations, the central banks’ actions are critically dependent upon the evolving economic outlook. Timely surveys can provide useful information on the likely course of economic activity in the near term,” says RBI in its new annual report, which was released on 30 August.
RBI has recently launched a survey of inventories, order books and capacity utilization in the corporate sector, to get some early indications of the business cycle. It has a quarterly industrial outlook survey. There is also talk of building leading indicators of future economic activity, including housing starts.
There is a lot of academic debate on the utility of central bank surveys. Take inflationary expectations. Some studies show that consumers tend to overstate future inflation in times of rapidly rising prices (as in the 1970s) and they tend to underestimate future inflation when the actual inflation rate is falling (as in the 1990s). There are also very valid questions whether surveys are more dependable than market indicators—like the spread on inflation-index bonds or the rate on inflation swaps. Of course, market-based indicators have little potential in India given the fact that trading in inflation-indexed bonds is minimal.
The point here is not how good and useful surveys really are. The point is that central banks are listening to what economic agents are saying and expecting. This is a far cry from the dark picture painted by Greider and dozens of other central bank hunters. There is a lot to be said against central bank secrecy in India, but the fact that RBI has started talking so regularly to ordinary citizens is laudable.
Meanwhile, here’s something that the current chairman of the US Fed, Ben Bernanke, told his audience at the recently concluded monetary policy shindig at Jackson Hole, a town in the US state of Wyoming. “… In light of recent financial developments, economic data bearing on past months or quarters may be less useful than usual for our forecasts of economic activity and inflation. Consequently, we will pay particularly close attention to the timeliest indicators, as well as information gleaned from our business and banking contacts around the country,” said Bernanke.
Though he was talking about the challenges of crafting monetary policy in turbulent times such as these, the very fact that the world’s most powerful central banker admits that studying past data is sometimes less important than speaking to contacts is important, and heart-warming for financial journalists who also seek a balance between data and what their business and banking contacts tell them!
The high priests are thus not only looking at the stars to understand the future; they are also busy listening to what ordinary souls around them are saying.
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