The Bank of Canada’s communication is critical during uncertain economic times and plays an influential role in consumer behaviour. These communications are usually designed to incite a specific behaviour. For example, communicating the Bank’s move to lower interest rates is designed to encourage people to take advantage of this relative opportunity and borrow money.
Often, these communications do not result in the intended reaction. This is because most macroeconomists—like me—are used to working with simplified models of human behaviours, which limits the accuracy in our projected outcomes.
These models assume rational behaviour and complete financial literacy which is not accurate and can lead to unrealistic predictions. The reality is that people’s reactions to central bank communications are as complex and varied as their financial and economic literacy.
My research focuses on expectations and decision-making in macroeconomic environments. I have created a laboratory economy where we can test policy and communications from the central bank.
We now have new data to explore how human behaviour could influence and be influenced by monetary policy. Preliminary evidence demonstrates that simple and accessible communication can be an effective tool during difficult economic times.
Working in partnership with the Bank of Canada, my research combines economic theory, data visualization, computational linguistics and laboratory experimentation to investigate the ability of monetary policy and central bank communication to stabilize and guide expectations and markets.
In a series of controlled laboratory experiments, Oleksiy Kryvtsov, senior research officer from the Bank of Canada, and I tested the causal effects of central bank communications on economic expectations and their underlying mechanisms. In an experiment where subjects learn to forecast economic variables, we found that central bank communication has a stabilizing effect on individual and aggregate outcomes. The size of the effect varies with the type of communication.
We found that highlighting past interest rate changes is the most effective way to communicate to the general public. It has shown to significantly reduce volatility or unpredictable reactions to banking communications.
This experiment effectively puts the human back into the equation and is evolving the traditional model assumptions on human behaviour. We are learning that communication is effective through simple and relatable backward-looking announcements that exert strong influence on less-accurate forecasters. We now know that increasing the accessibility of central bank information to the general public is a promising direction for improving their communication.
These new insights can be a game changer during tough economic times, where strong central policy combined with a greater understanding of our populations reactions could help minimize the severity of economic downturns.