Some thoughts on monetary policy

A fundamental principle that accompanies the effectiveness of the anti-inflationary policy is that the central bank enjoys credibility and confidence. The virtuous circle is when fulfilled commitments create reputation, with which credibility is built.

Frequent revision of inflation forecasts, as Banco de México does in each monetary policy decision statement, runs the risk of not conveying a solidly anchored commitment. The analytical and practical recommendation is that a good application of the communication instrument known as “forward guidance” is much more powerful in anchoring credibility than frequent changes in forecasts. Banco de México already uses “forward guidance”, so it should not emphasize its forecasts so much. In the end, what counts is the unwavering commitment to the quantitative inflation target.

In the analytical models of monetary policy, the expectations of the public and/or market play a fundamental role. The formation of expectations feeds on the transparency of the information and its explanation. This seeks to anchor long-term expectations around the goal. Expectations are measured through a periodic survey. But how to choose the relevant population? The three surveys (Banxico, Imef and CitiBanamex) are carried out among a group of economic analysts. This introduces a bias, but as long as there are no surveys for the general population or other groups, it is the best approximation available to measure “market expectations”.

Going back to the analytical context, when expectations are unanchored, it is most likely that all economic agents would not do so simultaneously, that is, the changes in expectations are not uniform. It depends on information asymmetries. Those who are better informed will adjust their expectations more quickly. The dynamics of changes in expectations that lead to price changes is complex, since these are staggered throughout the different sectors and the flexibility of prices is variable, there are some prices that are more “sticky” than others.

The credibility is with respect to the institution but above all with respect to the Governing Board. The different compositions of the Board over the years have different degrees of credibility, in addition to the fact that the different economic context is decisive. For example, the credibility of the Board from 1996-2009 cannot be compared with that of the current integration.

In the end, for a central bank, the effectiveness of monetary policy, in addition to correctly applying the anti-inflationary instrument, requires the interaction of transparency, communication, anchored expectations, commitment and proven reputation, and credibility. Although Banco de México has made progress in all of the above, in the current situation it still has to overcome several challenges, such as a more fluid and structured communication policy for all types of audiences and with clearer rules for the communication exercised by the members. of the Governing Board.

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