Some officials at Bank Indonesia have been faulted for misbehavior. Of course, any misdeeds in a public agency can be aided and abetted by the lack of openness of their operations.
However, a distinct issue arises over whether it is necessary for central bankers to be more transparent in their monetary policy-making decisions. The idea is that openness in their decisions will help shape expectations that in turn influence the transmission of monetary policy.
Supposedly, greater transparency contributes to more effective monetary policy and more "anchored" inflation expectations that lead to lower interest rates. As such, shocks can be avoided, thereby reducing price level volatility and promoting price stability.
Presumably, timely interventions by policy makers can steer an economy on a stable path by convincing individuals that all is well. This implies that economic fundamentals can be changed and conditions that precede a decline can be reversed.
While this conventional wisdom is almost universally accepted, there is much less than meets the eye. Indeed, it is nonsensical since many actors are widely ignorant of how economic forces operate.
It turns out that expectations are neither necessary nor sufficient conditions for price levels to rise. Economic theory and historical evidence point to an inflated money supply as the fundamental cause of persistent increases in prices.
If the money supply is not inflated, there can be no general rise in prices regardless of inflationary expectations. Even if sudden, sharp increases in energy or food prices cause expectations of higher inflation, it cannot occur without an excessive rate of expansion of the money stock.
In all events, the truth is that inflationary expectations are not a primary cause of anything and are themselves caused by loose monetary and credit policy. Rising expectations do not cause "inflation" and have no lasting impact on economic conditions unless accompanied by an excessively-expanding growth rate of money.
Expectations expressed by consumers or businesses, per se, are only important to the extent that their anticipations correspond to economic realities in the future. If central banks provide artificially-cheap credit by inflating the money supply, some investors can gain the means to engage in ventures that would turn out to be unprofitable at higher rates of interest in the future. Without monetary expansion or new bank-financed credit, investors that miscalculate future costs will cause transactions in the rest of economy to fall in an offsetting manner.
Transparency in monetary policy as a way of communicating the rate of monetary growth is fundamentally irrelevant. This is because the impact of changes in the rate of growth of the money supply on the economy will be the same whether the change is expected or unexpected.
And the harm done to the economy does not depend on whether the rate of money growth is anticipated or not. A fully-anticipated rate of increased growth of money will not fall evenly into each and everyone's hands.
Some individuals will receive some new money first while others get it much later as it trickles into the economy. As such, those spending newly-received money quickly gain real wealth that is lost by those that spend it later or last when they face greater scarcities and higher prices. Even if new money could be created so that everyone gets the same amount at the same time, individuals having different demands for money will all react differently.
An expansionary monetary policy allows banks to create credit, and thus money, as though out of "thin air". Issuing more currency un-backed by previous new real wealth allows for nothing to be exchanged for something by diverting real savings from wealth generators to borrowers. This redirection of the real pool of savings has a negative effect even if all individuals have clear expectations of monetary policies.
Central banks can engineer an extended deviation of expectations from economic realities that lead to activities that weaken the future development of real wealth formation. By losing touch with reality, individuals may make choices followed by an inevitable bust at a future date.
Increased rate of money supply growth allows consumption unsupported by production of new real wealth that weakens the pool of savings and hinders economic growth. Printing new money only diverts real savings from wealth-generating activities towards non-productive, wealth-consuming activities that cannot lead to net economic growth.
Tampering with the economy, even with transparent monetary policy, allows expectations to diverge from fundamental and sustainable economic realities. As such, loose monetary policy will always weaken the foundations of the real economy, regardless of expectations.
Managing perceptions and expectations cannot alter economic fundamentals since actual impacts are felt even if people are unaware of policy changes. Once central banks discern a need to tighten their monetary stance, an economic bust is already under way.
And so, it is impossible to manipulate price indexes and interest rates to concoct an efficient allocation of resources that lead to steady economic growth. Regardless of transparency, tighter monetary policy will trigger an economic bust with the severity determined by the length and magnitude of preceding loose monetary stance.
The writer is Research Scholar at the Centre for Civil Society in New Delhi and Visiting Professor of Economics at Universidad Francisco Marroquin in Guatemala. He can be reached at CLingle@ufm.edu
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