Question on Central Bank comunication

In a recent discussion at a Board of Directors meeting of Econometrics Inc., two statements were made regarding the importance of communication between a central bank and the financial markets. The statements were: Statement 1: “Poor communication by central banks of their intent can lead to uncertainty, instability in the financial markets, and unanticipated policy decisions that can disrupt financial markets.” Statement 2: “Central banks around the world should communicate clearly and transparently to the financial markets that they will preserve their policymaking flexibility when threats to price stability emerge.” Are Statement 1 and Statement 2 as made by the Board members correct? Statement 1 Statement 2 A) Correct Correct B) Correct Incorrect C) Incorrect Incorrect D) Incorrect Correct I am asking you in regard to statement 2. Alex.

I’d say Statement 1 is a correct statement. I’d say the second statement seems correct too. A central bank, committed to preserve price stability, and making it clear to the market, would allow market participants to easily understand and adjust in anticipation of a central bank measures toward price stability preservation. The market would move in the desired direction, making the policy easier to implement, with lesser effort from the central bank. So, is it A?

Answer = B

Is there a word missing in #2? Are they communicating “that they will preserve…” or are they communicating “so that they will preserve”?

the question is word to word taken from Qbank.

Statement 1 is a correct statement. Statement 2 is an incorrect statement. Answer = B. I think I’m right. So what’s the answer?

I think they are both correct. It’s all about credibility. If the govt lacks credibility when they say that they are going to do something no one is going to believe them and the situation is only becomes worse. At least that’s what I remember reading from the text.

Then again the whole "preserve their policymaking flexibility when threats to price stability emerge.” sounds a lil iffy. Preserve flexibility when threats to price stability emerge? I don’t know that doesn’t sound right. What’s the answer?

I say they are both correct, that’s my final answer!

If the Fed came out with a statement today “we are preserving our policy making flexibility” wouldn’t everyone just scratch their heads and keep going? Who cares?

^ i agree with your point Joey. Also the Fed will have to make this statement everytime threats to price stability “emerge?” I don’t know how accurate that statement is.

Yea but that’s not what the statement says. The statement says that the Fed should communicate clearly and transparently to the financial markets so that when they do come out and say something, it’s believable therefore helping them to maintain their power to be flexiable when making policies. either way that doesn’t make sense lol, after reading it again, I can’t see how that helps the fed be flexiable when making policies. I’m confused now and I hate econ. What’s the friggin answer? lol


I think statement 2 is incorrect. If the Fed says they will remove the risk of price stability, well, I think that opens up the system to gaming. Example - what if OPEC announces a cut in oil production. Clearly that would be a threat to price stability, so the Fed would act? Now, OPEC can simply force Fed to act one way or another whenever it wants? Doesn’t seem like sound policy. Think of other examples of a technological breakthrough that may drastically reduces costs across the economy. Is this a threat to price stability that the Fed should act on? That would seem to stop the mechanism of creative destruction of free markets. After having just re-read the question after typing this, I think it is very unclear what this policy is, making the statement almost trivial due to its lack of meaning. This is a long way of saying that B is the correct answer.