The European Central Bank will unveil a new strategy of openness later this month with a book by its chief economist Mr Otmar Issing spearheading the effort.
According to sources who have seen the draft of the book, Monetary Policy in the Euro Area, it will help explain how the European Central Bank (ECB) makes decisions. It also sets out a framework for how future decisions will be made.
The bank hopes to persuade the markets that it does in fact have rules for its policy-making. These set down that interest rate cuts will only happen when inflation in the medium term looks set to fall well below 2 per cent. The size of the likely cut will depend on the speed of the change of inflation expectations.
The first rule is that the ECB will not be "activist". This means that, so long as prices are expected to move within 0 to 2 per cent, the ECB will move only gradually, if at all.
However, if prices are expected to move out of that range on a sustained basis more aggressive and decisive rate moves will be undertaken. Activism is defined as an attempt to counteract the business cycle through interest rate policy. This is a trap which the ECB believes the Fed has fallen into, where it is a victim of the markets and market expectations remove its ability to conduct a rules-based monetary policy.
If the rules are applied to decisions so far, those decisions do make sense. By the same yardstick, further rate cuts are not yet on the cards. Any such cut would be triggered by a drop in inflation forecasts, perhaps as part of the latest growth forecasts. Sources believe the ECB would need to believe inflation faced a considerable drop rather than a gradual easing back to its 2 per cent target.
Another possibility would be that new economic forecasts show a dramatic weakening in euro-zone growth forecasts that threaten to plunge the 18 to 24month inflation forecasts to zero. This would result in a half-point cut and the first two in quarter point cuts, under the new logic.
For those who wonder how the meetings are run, sources say Mr Issing's book makes it clear that he controls the agenda although not the policy itself. This means that when he puts a recommendation to the governing council it can debate the recommendation but cannot bring up extraneous points.
The idea of the initiative is to move away from the perceived chaos of recent press conferences and interviews, which have left the public, the markets and indeed senior ECB officials confused. A new communications strategy may run alongside the book. The ECB has come under sustained criticism from much of the media as well as the markets for the perceived lack of clarity in its actions. Insiders have reportedly been almost as confused as outsiders in recent months and this is one of the reasons why Mr Issing was given permission to write the book. There are also a lot of questions being asked about Mr Duisenberg, following his disastrous handling of the rate cut and its aftermath in April.
According to Mr Jim Power, head of investment at Friends First, the ECB's strategy has been abysmal. "The majority of rate moves have taken the markets by surprise. We have no idea whatsoever what the 18 members of the board are thinking. Mr Duisenberg's disastrous performance can be seen in the performance of the euro."
Others are less critical. According to Mr Brian Martin, global currency strategist at Barclays in London: "The ECB is caught between a rock and a hard place and is not doing that poorly." Mr Peter Hamilton, of Medley Global Advisors in New York, says: "They've had severe problems with communication recently, but they are much more coherent and effective than people give them credit for."
