Address by Mr T.T. Mboweni, Governor of the South African Reserve Bank, At the Star/Safmarine Breakfast, Johannesburg Country Club, 7 September 2006 Honoured guestsLadies and gentlemen Introduction Central banking has come a long way since the days, not too many years ago, when monetary policy was shrouded in secrecy. Central bank communication was akin to deciphering an obscure biblical tract, and monetary policy very often surprised the markets. It is almost unbelievable that as recently as 1994 the US Federal Open Market Committee (FOMC) did not even announce the monetary policy decision, let alone the justification thereof, and it was left to the market to infer from the Fed’s actions in the market whether or not there had been a change in the monetary policy stance. The monetary economist, Karl Brunner, was most scathing in his criticism and in 1981 argued that the peculiar mystique surrounding central banking thrived on the pervasive impression that central banking was an esoteric art confined to the initiated elite. He further added that “the esoteric nature of the art is moreover revealed by an inherent impossibility to articulate its insights in explicit and intelligible words and sentences”. As we know, things are very different today. The pendulum has swung in the opposite direction, prompting Alan Blinder, a former Vice-Chairman of the US Federal Reserve System, to refer to it as the ‘quiet revolution’. Much of the debate about communication now focuses on the issue of whether central banks can be too transparent. Notable economists in the field such as Blinder and Lars Svensson argue for maximum transparency, while others, for example Frederic Mishkin, argue that there are limits to transparency. I will argue today that transparency and communication are a function of the decision-making process and particular institutional features, which in effect means that no single approach can be regarded as ‘best practice’. In looking at issues such as transparency and communication, the point must also be made that communication is a two-way street. Making monetary policy also involves giving attention to signals coming from the market. Indeed, the argument is sometimes made that the central bank should simply follow the market, raising the question of who takes the lead. 2. Communication from the market to the Bank It is generally agreed that there is much market information of a forward-looking nature that is extremely useful for monetary policy. Sometimes central banks will follow market movements which can provide information about the outlook that is independent of policy and that is crucial to monetary policy decisions. Prices and interest rates incorporate all information available to the market, and therefore provide important signals about the future. True, there are times when the central bank may have information that is not in the public domain, but equally, many private sector institutions are privy to certain information, or may have superior information because of specialised research in a particular area. Hence a two-way flow of information does exist in practice. The Bank therefore takes market information very seriously and we look at a number of forward-looking indicators. These include the forward rate agreements (FRAs), the yield curves and yield spreads, break-even inflation rates, the Reuters consensus forecasts and the implied forward exchange rate curves, to name a few. We are also in the privileged position to receive a wide range of detailed in-house research from domestic and international financial institutions. These give us some indication of market expectations concerning various variables. There is a rich literature on the information content of yield curves. The generally accepted wisdom is that monetary policy determines the very short end of the curve to a significant degree. However monetary policy does not determine the long-term rates. These are determined by a number of variables, including real output growth and the market’s expectation of long-term inflation and expectations