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The major challenge facing central banks today is the inability of existing policymaking frameworks to adequately deal with significant and increasing uncertainty. Martin Galstyan (Governor of the Central Bank of Armenia) proposes a new policymaking setup “FPAS Mark II” that combines successful parts of the institutional framework of Mark I systems with an MPRM approach to dealing with uncertainty.

Image courtesy of interviewee. March 15, 2024

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This video video is a transcript of a discussion focused on the Central Bank of Armenia's approach to monetary policy and risk management in the context of economic challenges. The speaker emphasizes that as a small developing economy, Armenia cannot solely rely on inaction for achieving macroeconomic stability, given the multitude of risks it faces, particularly highlighted during recent crises, such as COVID-19 and geopolitical conflicts.

Key points include:

1. **Understanding and Managing Risks**: The central bank aims to develop frameworks to effectively manage risks instead of avoiding them altogether. This video video involves a shift from relying on single baseline forecasts to a scenario-based approach that allows for more nuanced understanding and communication about economic uncertainties.

2. **Enhancing Communication**: There is a focus on transparency in decision-making processes, with initiatives to publish board deliberation minutes and individual board member submissions on the same day as policy decisions. This video video is designed to provide stakeholders a clearer view of the central bank's considerations, strengthening trust and credibility.

3. **Lessons from Global Trends**: The post-COVID inflationary period and its implications on policy credibility are discussed, underscoring the need for careful communication with the public and markets to maintain central bank integrity. The speaker cites the Reserve Bank of New Zealand as a successful example in adopting flexible inflation targeting and employing a 'least regrets' policy stance during crises.

4. **Fostering Public Understanding**: There is an emphasis on economic literacy among the general public as a necessary public good, contributing to societal capacity building, which, in turn, aids in enhancing the central bank's credibility.

5. **Investments in Human Capital and Analytical Tools**: The need for skilled personnel and sophisticated analytical frameworks to support effective monetary policy is highlighted, ensuring that economists bring both analytical and narrative capabilities to their work.

Overall, the discussion advocates for an evolved approach to monetary policy that prioritizes communication, scenario-based risk management, and operational transparency to navigate uncertainties effectively.

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X-TIMESTAMP-MAP:LOCAL=00:00:00.000,MPEGTS=900000

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So let me begin by briefly providing some context first.

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Um, as a small developing open economy

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situated in a very precarious corner of the world,

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we at the Central Bank of Armenia are always aware

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of the fact that we cannot rely on sheer lack

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or inertia to achieve the price

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or macroeconomic stability in the country.

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So risks are always present more dangerous than others.

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Some of them are more, more dangerous than the others,

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and many of these risks do in fact materialize.

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For us, the essence of good governance

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and good policymaking is the ability to weather

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whatever comes on our way

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and avoid the dark corners

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as Olivia Blanchard described those.

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So for us, the question has always been not whether,

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we can avoid risks altogether,

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but rather whether we can have the type of framework

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that helps us to effectively deal with

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and manage those risks.

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In other words, when we make forward looking policies,

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does our framework help us mitigate

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rather than abbreviate the risks

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and uncertainties that we face?

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So this way of thinking about the risks

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and uncertainty became, probably more crystallized

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during the covid crisis

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and the inflationary period that followed the covid crisis.

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Looking globally under particularly advanced economies,

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we were clearly in the first real inflationary period

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for decades, and there existed enormous amounts

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of uncertainty about what was driving it

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and how policy owed to respond.

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This created new communication

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and credibility challenges for advanced central banks.

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Problems that many thought have been put in bed since

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probably 1980s in advanced economies,

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the post covid period served as a difficult reminder

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that policy credibility cannot be taken for granted.

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That policy errors

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and uncertainty can create real welfare implication

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that ripple throughout the globe.

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So, in Armenia, this period made

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all the more challenging

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because of the fact that we were facing a complex

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layering of crises.

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Many of those that included not just covid,

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but also we had war and regional geopolitical shifts.

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So while we, appropriately dealt with these challenges

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and avoided worst case outcomes in dark corners,

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I think we start thinking at the same time

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what the best policy framework

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would look like in the future.

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So in that sense, we asked several questions to ourselves,

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and first would be like in the face of such uncertainty,

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how could one develop a single interpretation?

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And I want to stress the word single

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because most of the central banks, including ourselves,

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were relying on this

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Single forecast line, which we call baseline.

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So, and the forecast that future.

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So can we forecast the future with any degree of legitimacy?

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That was the first question.

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The second one was, what type

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of communication would effectively convey the richness

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and complexity of our policy discussions within the board

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and without minimizing uncertainty that we were facing?

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So we didn't want to give our general public

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or professional audience this false assurance

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that we are the ones who know the best.

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So there is, there were rich discussions

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with multiple scenarios in the board,

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and what we thought is a good idea is to replicate that

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and to provide this richness to the public

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so they can make their own decisions.

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And the third thing that we tried to have, have our heads

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around was whether we should serve.

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And that would be probably the, the kind of extension

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to problem number two, whether we should act as a

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expert forecaster in this case,

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or we should effectively manage the risks and uncertainty

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and be very honest.

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And humility would be part of that.

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Also telling that we are not the ones who know all the best,

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but these are the options that we have discussed.

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And this what we think

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how the risk management should look like.

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This is an analytical work which is based on,

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comments or approaches made by Alan Greenspan in 2004,

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I think, if I'm not mistaken.

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And he called it monetary policy as a risk management.

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So we take that approach

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and try to create an operational framework,

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which is based on models and everything underneath.

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But the basic idea was to apply to this monetary policy

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as a risk management framework

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and to enrich that the term monetary policy

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as risk management originated from Alan Greenspan,

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who implemented versions

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of this approach at the Federal Reserve.

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However, the fed's use of

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MPRM largely happens on the internal level,

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and a lot of the richness

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and benefits of this approach is lost when it comes

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to external communication.

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So for example,

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they do not immediately publish certain documents

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or analysis that shed light on the different risks

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and uncertainties being considered at the board of FYMC.

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Our approach under FPAs mark two, is to take a lot

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of the foundational

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and conceptual elements of NPRM approach,

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but augmented with significantly more transparency

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about how we arrive to our decision.

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So that is critical.

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So this includes not only following the very highest

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standards for policy communications, but also publishing

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Our key communication materials in virtually real time.

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So for example, our monetary policy report on the

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attributed minutes of the board.

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So how board deliberates on on the, the, those issues

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will be published on the same day as the decision is made.

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So we are trying hard to do that.

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We had just first example couple of days ago.

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It's extremely hard

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because it puts a lot of pressure on the team

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who does the stuff plus on the board and including myself

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because I need to prepare myself also

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for the press conference.

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So that takes hell of a time,

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but we are committed to be completely transparent.

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So in that sense I think that's, that's a good approach.

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In terms of application, I think the Federal Reserve Bank

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of New Zealand is probably the most relevant for us,

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considering their success

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with implementing flexible inflation targeting

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and least regrets policymaking.

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Additionally, like us, like Armenia,

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they are also a small open economy

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and despite being a small country, they managed

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to set the global standard for central banking practice,

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which is also something that we aspire to do

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with this new framework.

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One good example of Reserve Bank

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of New Zealand has been their use of policy of least regrets

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during the covid, which is also an important component

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of the decision making process in our framework.

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So in the immediate, onset of the Covid pandemic,

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the RBNZ communicated policy of least regrets,

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recognizing early on that they were knowing knowingly taking

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a very easy monetary policy stance in order

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to support demand in the economy.

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During the covid lockdowns, they recognized

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and communicated that they simply did not know the extent

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of the decline of the demand

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that would occur when the economy shut down.

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Therefore, early on they communicated that a clear risk

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of this policy is

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that it would potentially mean higher inflation in the

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future during the recovery phase,

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but that they were willing to take this type of risk

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because the risk of not doing enough to support the economy

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during the pandemic was unacceptable.

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So potential might be lost.

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So they were kind of contemplating between two risks

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and they came up and they were extremely honest in their

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communication, telling their general public

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that they clearly understand that the outcome might not be

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as what they wish to be,

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but there are more dangerous risks on the downside

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where the entire economy could collapse.

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So those are the few examples that I just want to mention

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to you, if I may call it innovation.

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The key innovation of our framework from an operational

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and procedural point

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of view is shifting the focus away from a single

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narrow baseline forecast

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To a scenario based approach as I mentioned earlier.

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So during each forecasting ground, our economists,

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who work with a board very closely,

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they built the best arguments, the best cases they can make

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for why the future path of the policy rate should be higher,

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which we call case a higher than what market expects

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or lower as we call the case B.

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Then what is currently priced in.

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So the financial markets have their own forecast,

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the one which is higher, we call it case A, which

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it means basically that we do expect

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that inflation will be higher for longer

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or something like that, or downside risks on the demand

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side, which would be incorporated in case B.

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So in practice this happens through intense discussions

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between the team and the board in terms of coming up

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with a very broad set of relevance scenarios.

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Um, and then from this broad set of scenarios,

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we choose two illustrative ones for case A

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and case B, which are basically used

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for our external communication.

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But discussions

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and decision making itself continue to be motivated

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by the broader set of scenarios.

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So though we illustrate and communicate the exemplary ones,

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but at the same time within the board, within the boardroom,

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we discuss much broader scenario base that we have at our,

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under our control.

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So this achieves a few goals for us.

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First, through this process, we hope to embrace

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what is known as adversarial collaboration.

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Daniel Kahneman has got a paper on that about him

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and his wife being working on that field.

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So second, with this new approach,

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we are much more focused on, on understanding

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and debating what the policy relevant risks are

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that could threaten price stability

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and how we ought to respond to them rather than

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structuring our policy discussion

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around the baseline scenario.

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So this is, probably two major important ones

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and probably the third is

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that the framework requires engagement within development

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of financial markets.

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Since our scenarios are prepared relative

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to the current market pricing in the financial markets.

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So we should be very clear with them

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where we see the future would like look like the summer

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of 2021 is probably almost a textbook example of,

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there being two possible

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or plausible scenarios

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that were very different implications

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from the policy perspective.

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Our firm perspective is

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that relying on such a scenario based approach during

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that time would have been very helpful

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to prepare the central bank

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and financial markets

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for higher interest rates when inflationary risks began

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to materialize and to have avoided some

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of the policy errors at that time.

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So in our framework, is,

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so we had this scenario with that the case say with a more,

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sticky kind of inflation where interest rates would need

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to be higher than market expectations.

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So this echoed views expressed by many in the field,

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including our, one of our most famous ones, Larry Summers,

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who argued that the combined fiscal

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and monetary stimulus was too big

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and represented a grave economic error.

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In particular, the primary concern that this camp voice was

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that aggregate demand was already pushing up against

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aggregate supply

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and thus translating into higher inflation,

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which would be exacerbated by such high stimulus

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once the economy fully reopened.

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And we somehow agreed,

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but there is also the second part,

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so the other scenario which is inflation is

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transitory in us.

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That scenario, this is similar

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to probably other arguments voiced at that time that

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supply side factors connected

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to the covid lockdowns were the main contributor

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to the rise of inflation.

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Therefore, given that was assumed to be a temporary nature

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of the supply disruptions, inflation expected

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to peter out over coming quarters, so it will come back.

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Thus the PR policy rate could be normalized in line

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with still recovering labor market.

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And then what we were telling through our framework is

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that if you go out

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and communicate with the markets both of these scenarios

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and trying to tell them the richness of the story,

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that would've preserved your credibility much more than

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trying to compress everything this diversity into one

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baseline, which was believing in transitory

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and somehow being wrong

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and then somehow risking your own credibility

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and tying your hands in terms of policy action.

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Because previously you over

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and over have repeated that this is transitory phenomenon

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and then when you somehow betrayed your first inception,

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then it's for you hard to go and explain how wrong you were.

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So let me begin by mentioning that FPA mark one

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I think was an important

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and necessary first step

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for developing the analytical capacity in our own bank,

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I think in other banks as well.

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And, there are many core aspects of FPAs mark one

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that have stood the test of the time

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and owed to be preserved and augmented.

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I think with that being said, the past few years have

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of course drawn attention to several drawbacks related

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to FPAs mark one,

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and that will touch upon just a few of them.

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So the current approach of monetary policy,

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the current approaches of the monetary policy, and

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therefore the communication strategies critically

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Hinge on the ability of the central bank

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to project the future and design optimal policy responses.

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Now, that is a problem

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because we can easily see that it,

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it is essentially impossible to make a forecast in times

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of critical uncertainty.

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So moreover, dropping such projections in the close

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of assurance and confidence has the potential

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to mislead both policy makers

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and economic agents by providing this false sense

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of security when we are planning at the same time

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and as much as the central bank tries to add disclaimers

15:28.775 --> 15:31.035
to it, projections, the mismatch

15:31.035 --> 15:32.555
between baseline projections

15:32.575 --> 15:36.195
and what, what actually materializes can have very real

15:36.255 --> 15:39.635
impact on credibility as we were discussing in the case

15:39.635 --> 15:40.635
of 2021.

15:41.065 --> 15:45.475
Finally relying on baseline single forecast that's,

15:45.545 --> 15:49.715
somehow a narrow vision, how risks will materialize

15:49.715 --> 15:52.995
and what will happen in the future can create huge problems

15:52.995 --> 15:54.435
in terms of policy agility

15:55.375 --> 15:58.635
and unnecessary type policymaker hands.

15:59.695 --> 16:02.315
So, another thing that we have noticed

16:02.375 --> 16:04.035
and I would like to highlight is that

16:04.815 --> 16:08.595
FPA mark one has a tendency to be a model centric approach

16:08.895 --> 16:10.475
to monetary policy analysis.

16:11.355 --> 16:15.035
Although models are very important component of,

16:15.535 --> 16:19.275
any solid framework, I have nothing against,

16:19.565 --> 16:21.645
solid approach to that.

16:21.945 --> 16:23.845
But we do have a rule at the central bank

16:23.865 --> 16:27.685
and the rule is that our economist never say model says,

16:29.035 --> 16:30.495
so it's their own judgment.

16:30.605 --> 16:32.415
They can use models as tools,

16:32.875 --> 16:35.255
but that that would be the economist own judgment.

16:36.205 --> 16:40.105
So, the greatest issue that we see here is that,

16:40.695 --> 16:42.385
over dependency on models

16:42.485 --> 16:46.145
and their outputs rather than underlying economics

16:46.245 --> 16:49.345
or quality of the e economists running the models

16:49.645 --> 16:52.665
and conducting analysis is, is a real problem.

16:53.125 --> 16:57.265
So we decided that we need to equip our own economists

16:57.775 --> 16:59.345
with tools necessary,

16:59.885 --> 17:02.105
but at the same time there should be a solid

17:03.185 --> 17:04.865
economic judgment behind everything.

17:05.165 --> 17:06.225
And probably you remember

17:06.225 --> 17:09.745
what Stanley Fisher said about Bob Solo is, do you know

17:09.745 --> 17:12.545
that phrase he used during one of his set?

17:12.565 --> 17:15.745
He said, I would rather have Bob solo than an

17:15.745 --> 17:18.825
econometric model, but I would rather have Bob solo

17:18.855 --> 17:21.545
with an econometric model than without one.

17:22.005 --> 17:23.385
So that would be my short answer.

17:24.045 --> 17:27.705
So our robust communication framework is arguably the most

17:27.705 --> 17:29.585
important aspect of this new framework.

17:29.605 --> 17:32.945
So we'll put a lot of emphasis on communication, so

17:32.975 --> 17:35.265
that is very important from external point of view,

17:35.885 --> 17:37.105
our framework is first

17:37.245 --> 17:41.505
and foremost built upon the need of transparently clearly

17:42.045 --> 17:44.505
and effectively convey to our key stakeholders

17:45.005 --> 17:47.465
how the central bank is thinking about key sources

17:47.565 --> 17:48.825
of risk and uncertainty.

17:49.575 --> 17:52.805
Using this idea as our main motivator,

17:52.905 --> 17:55.605
we built a comprehensive framework for communications,

17:55.885 --> 18:00.165
transparency, accountability, which seek to achieve,

18:00.645 --> 18:02.445
probably six fundamental principles.

18:02.445 --> 18:04.725
Principle number one would be to provide clarity

18:05.385 --> 18:07.085
on monetary policy objectives.

18:08.345 --> 18:10.845
Number two, offer transparency about decision

18:10.845 --> 18:12.205
making process itself.

18:12.995 --> 18:16.265
Three would be ensure policy agility in the face of risk,

18:16.335 --> 18:20.185
uncertainty and dynamically evolving economic conditions.

18:20.765 --> 18:22.025
Fourth, provide markets

18:22.205 --> 18:26.065
and stakeholders with a combination of qualitative

18:26.445 --> 18:28.185
and quantitative forward guidance.

18:28.845 --> 18:30.145
Number five, support

18:30.165 --> 18:32.145
and strengthen central bank credibility.

18:32.645 --> 18:35.905
And number six, provide full transparency about analytics

18:36.405 --> 18:40.225
and data and the toolkit that the central bank uses

18:40.225 --> 18:41.265
to conduct the analysis

18:41.265 --> 18:42.785
and the support of its own decisions

18:43.365 --> 18:44.865
to achieve this principles.

18:45.205 --> 18:48.825
Um, we recognize that we have numerous different groups

18:48.885 --> 18:50.945
of stakeholders that serve

18:51.085 --> 18:53.705
as our target audiences in our communication.

18:54.445 --> 18:57.025
Uh, I think those group would include the general public

18:57.025 --> 18:59.345
first and foremost, but also medium journalists,

18:59.655 --> 19:01.825
financial markets specialist, academia,

19:02.235 --> 19:04.225
government ifi and so on.

19:04.525 --> 19:06.065
So of course the target audience

19:06.065 --> 19:09.865
for monetary policy communications I di are very diverse

19:09.925 --> 19:10.945
and wide ranging.

19:11.445 --> 19:14.625
So which means that we need to work,

19:14.695 --> 19:17.225
also on economic literacy for the general public,

19:17.475 --> 19:20.505
which is from our perspective is providing the social

19:20.805 --> 19:22.785
or public good in that sense.

19:23.125 --> 19:25.985
But at the same time we have different approaches

19:26.005 --> 19:29.745
for different layers and groups how to communicate.

19:30.205 --> 19:33.105
So under FPA mark two, we place a very high degree

19:33.205 --> 19:36.145
of emphasis on being highly transparent about

19:36.765 --> 19:38.305
how we're thinking about the economy

19:38.565 --> 19:40.945
and how we arrive to our decision.

19:41.985 --> 19:44.805
In support of this, we have began publishing attributed

19:44.805 --> 19:47.005
minutes of the deliberation

19:47.005 --> 19:49.805
that led the board's decision on the same day

19:50.185 --> 19:51.845
as decision itself is published.

19:52.105 --> 19:53.285
We never did that before.

19:54.115 --> 19:55.565
This allows our stakeholders

19:55.625 --> 19:59.725
to understand in almost real time the dynamic

20:00.525 --> 20:02.725
surrounding in the key policy relevant issues.

20:03.255 --> 20:05.645
We'll be publishing attributed votes as well

20:05.985 --> 20:08.245
and the individual submissions of each

20:08.245 --> 20:09.725
and single board member.

20:10.395 --> 20:12.605
This means that readers will get to see

20:13.305 --> 20:15.365
on decision day the concerns

20:15.365 --> 20:17.565
that motivated each board member

20:18.145 --> 20:20.525
and thus have a much richer, more transparent

20:20.785 --> 20:23.165
and more comprehensive understanding of

20:23.195 --> 20:26.285
what the key issues which are driving our decision.

20:26.865 --> 20:28.485
But at this point I think we need

20:28.485 --> 20:30.005
to have systematic attention

20:30.105 --> 20:31.885
to policy risks and uncertainties.

20:32.225 --> 20:36.205
So the primary challenge facing the central bank is

20:37.225 --> 20:41.165
the inadequate inadequacy in terms of

20:41.885 --> 20:42.925
existing policy framework.

20:43.025 --> 20:46.885
So we think that we should be leading that, that work. The

20:46.885 --> 20:50.245
Second one would be huge investment in human capital.

20:51.065 --> 20:53.765
So we need to have a people of that caliber

20:54.305 --> 20:56.525
who would use analytical tools

20:56.865 --> 20:58.845
but at the same time would come to us

20:59.185 --> 21:00.685
and tell us the narratives as well.

21:01.105 --> 21:04.565
So that is, that is a very com very nice combination of

21:05.105 --> 21:08.245
skills which we're working on with, with our own people.

21:08.955 --> 21:11.965
Then the third will be probably investing in Ali

21:11.965 --> 21:15.085
analytical framework and model models themselves.

21:15.585 --> 21:19.485
So making them better, to include

21:20.215 --> 21:21.405
basic nonlinearities

21:21.465 --> 21:23.845
but also something which is much more complicated.

21:25.705 --> 21:27.525
Fourth will be probably transparency

21:27.585 --> 21:31.725
and accountability in terms of us being accountable

21:31.825 --> 21:33.085
to our general public.

21:33.625 --> 21:36.525
And, throughout you you see the red line

21:36.525 --> 21:39.085
and the way of thinking from our side is

21:39.085 --> 21:43.095
that our public good is to provide people with

21:43.355 --> 21:46.495
as much information so they understand better

21:46.635 --> 21:47.775
how we make decisions.

21:48.595 --> 21:50.855
And probably related to

21:50.855 --> 21:53.535
that also will be societal level capacity building

21:53.725 --> 21:57.535
because by providing that impetus, we're also building,

21:57.535 --> 22:00.095
financial literacy blocks within the society, which

22:00.615 --> 22:03.455
probably would help to build credibility with us.

22:03.875 --> 22:06.615
And having people believing in central bank's policy

22:07.575 --> 22:10.655
probably would be the best reward that we can accept,

22:10.685 --> 22:13.095
like expect the trophy of the day.

Managing Economic Risks in Armenia's Central Bank

00:00:00 - So let me begin by briefly providing some context first. as a small developing open economy situated in a very precarious corner of the world, we at the Central Bank of Armenia are always aware of the fact that we cannot rely on sheer lack or inertia to achieve the price or macroeconomic stability in the country. So risks are always present more dangerous than others. Some of them are more, more dangerous than the others, and many of these risks do in fact materialize.
00:00:33 - and good policymaking is the ability to weather whatever comes on our way and avoid the dark corners as Olivia Blanchard described those. So for us, the question has always been not whether, we can avoid risks altogether, but rather whether we can have the type of framework that helps us to effectively deal with and manage those risks. In other words, when we make forward looking policies,
00:01:05 - rather than abbreviate the risks and uncertainties that we face? So this way of thinking about the risks and uncertainty became, probably more crystallized during the covid crisis and the inflationary period that followed the covid crisis. Looking globally under particularly advanced economies, we were clearly in the first real inflationary period for decades, and there existed enormous amounts
00:01:36 - and how policy owed to respond. This created new communication and credibility challenges for advanced central banks. Problems that many thought have been put in bed since probably 1980s in advanced economies, the post covid period served as a difficult reminder that policy credibility cannot be taken for granted. That policy errors and uncertainty can create real welfare implication
00:02:07 - So, in Armenia, this period made all the more challenging because of the fact that we were facing a complex layering of crises. Many of those that included not just covid, but also we had war and regional geopolitical shifts. So while we, appropriately dealt with these challenges and avoided worst case outcomes in dark corners,
00:02:38 - what the best policy framework would look like in the future. So in that sense, we asked several questions to ourselves, and first would be like in the face of such uncertainty, how could one develop a single interpretation? And I want to stress the word single because most of the central banks, including ourselves, were relying on this Single forecast line, which we call baseline. So, and the forecast that future. So can we forecast the future with any degree of legitimacy?

Enhancing Communication in Monetary Policy Decisions

00:03:11 - The second one was, what type of communication would effectively convey the richness and complexity of our policy discussions within the board and without minimizing uncertainty that we were facing? So we didn't want to give our general public or professional audience this false assurance that we are the ones who know the best. So there is, there were rich discussions with multiple scenarios in the board, and what we thought is a good idea is to replicate that
00:03:45 - so they can make their own decisions. And the third thing that we tried to have, have our heads around was whether we should serve. And that would be probably the, the kind of extension to problem number two, whether we should act as a expert forecaster in this case, or we should effectively manage the risks and uncertainty and be very honest. And humility would be part of that.
00:04:18 - but these are the options that we have discussed. And this what we think how the risk management should look like. This is an analytical work which is based on, comments or approaches made by Alan Greenspan in 2004, I think, if I'm not mistaken. And he called it monetary policy as a risk management. So we take that approach and try to create an operational framework,
00:04:47 - But the basic idea was to apply to this monetary policy as a risk management framework and to enrich that the term monetary policy as risk management originated from Alan Greenspan, who implemented versions of this approach at the Federal Reserve. However, the fed's use of MPRM largely happens on the internal level, and a lot of the richness and benefits of this approach is lost when it comes
00:05:19 - So for example, they do not immediately publish certain documents or analysis that shed light on the different risks and uncertainties being considered at the board of FYMC. Our approach under FPAs mark two, is to take a lot of the foundational and conceptual elements of NPRM approach, but augmented with significantly more transparency about how we arrive to our decision.
00:05:49 - So this includes not only following the very highest standards for policy communications, but also publishing Our key communication materials in virtually real time. So for example, our monetary policy report on the attributed minutes of the board. So how board deliberates on on the, the, those issues will be published on the same day as the decision is made. So we are trying hard to do that. We had just first example couple of days ago. It's extremely hard

Transparency and Innovation in Economic Policy

00:06:22 - who does the stuff plus on the board and including myself because I need to prepare myself also for the press conference. So that takes hell of a time, but we are committed to be completely transparent. So in that sense I think that's, that's a good approach. In terms of application, I think the Federal Reserve Bank of New Zealand is probably the most relevant for us, considering their success with implementing flexible inflation targeting and least regrets policymaking.
00:06:53 - they are also a small open economy and despite being a small country, they managed to set the global standard for central banking practice, which is also something that we aspire to do with this new framework. One good example of Reserve Bank of New Zealand has been their use of policy of least regrets during the covid, which is also an important component of the decision making process in our framework. So in the immediate, onset of the Covid pandemic,
00:07:28 - recognizing early on that they were knowing knowingly taking a very easy monetary policy stance in order to support demand in the economy. During the covid lockdowns, they recognized and communicated that they simply did not know the extent of the decline of the demand that would occur when the economy shut down. Therefore, early on they communicated that a clear risk
00:07:59 - that it would potentially mean higher inflation in the future during the recovery phase, but that they were willing to take this type of risk because the risk of not doing enough to support the economy during the pandemic was unacceptable. So potential might be lost. So they were kind of contemplating between two risks and they came up and they were extremely honest in their communication, telling their general public that they clearly understand that the outcome might not be
00:08:33 - but there are more dangerous risks on the downside where the entire economy could collapse. So those are the few examples that I just want to mention to you, if I may call it innovation. The key innovation of our framework from an operational and procedural point of view is shifting the focus away from a single narrow baseline forecast To a scenario based approach as I mentioned earlier. So during each forecasting ground, our economists,
00:09:04 - they built the best arguments, the best cases they can make for why the future path of the policy rate should be higher, which we call case a higher than what market expects or lower as we call the case B. Then what is currently priced in. So the financial markets have their own forecast, the one which is higher, we call it case A, which it means basically that we do expect

Scenario-Based Decision Making in Monetary Policy

00:09:34 - or something like that, or downside risks on the demand side, which would be incorporated in case B. So in practice this happens through intense discussions between the team and the board in terms of coming up with a very broad set of relevance scenarios. and then from this broad set of scenarios, we choose two illustrative ones for case A and case B, which are basically used for our external communication.
00:10:05 - and decision making itself continue to be motivated by the broader set of scenarios. So though we illustrate and communicate the exemplary ones, but at the same time within the board, within the boardroom, we discuss much broader scenario base that we have at our, under our control. So this achieves a few goals for us. First, through this process, we hope to embrace what is known as adversarial collaboration. Daniel Kahneman has got a paper on that about him
00:10:39 - So second, with this new approach, we are much more focused on, on understanding and debating what the policy relevant risks are that could threaten price stability and how we ought to respond to them rather than structuring our policy discussion around the baseline scenario. So this is, probably two major important ones and probably the third is that the framework requires engagement within development
00:11:09 - Since our scenarios are prepared relative to the current market pricing in the financial markets. So we should be very clear with them where we see the future would like look like the summer of 2021 is probably almost a textbook example of, there being two possible or plausible scenarios that were very different implications from the policy perspective. Our firm perspective is that relying on such a scenario based approach during
00:11:40 - to prepare the central bank and financial markets for higher interest rates when inflationary risks began to materialize and to have avoided some of the policy errors at that time. So in our framework, is, so we had this scenario with that the case say with a more, sticky kind of inflation where interest rates would need to be higher than market expectations. So this echoed views expressed by many in the field,
00:12:16 - who argued that the combined fiscal and monetary stimulus was too big and represented a grave economic error. In particular, the primary concern that this camp voice was that aggregate demand was already pushing up against aggregate supply and thus translating into higher inflation, which would be exacerbated by such high stimulus once the economy fully reopened.

Inflation Scenarios: Transitory versus Permanent Risks

00:12:44 - but there is also the second part, so the other scenario which is inflation is transitory in us. That scenario, this is similar to probably other arguments voiced at that time that supply side factors connected to the covid lockdowns were the main contributor to the rise of inflation. Therefore, given that was assumed to be a temporary nature of the supply disruptions, inflation expected to peter out over coming quarters, so it will come back.
00:13:19 - with still recovering labor market. And then what we were telling through our framework is that if you go out and communicate with the markets both of these scenarios and trying to tell them the richness of the story, that would've preserved your credibility much more than trying to compress everything this diversity into one baseline, which was believing in transitory
00:13:49 - and then somehow risking your own credibility and tying your hands in terms of policy action. Because previously you over and over have repeated that this is transitory phenomenon and then when you somehow betrayed your first inception, then it's for you hard to go and explain how wrong you were. So let me begin by mentioning that FPA mark one I think was an important and necessary first step for developing the analytical capacity in our own bank,
00:14:23 - And, there are many core aspects of FPAs mark one that have stood the test of the time and owed to be preserved and augmented. I think with that being said, the past few years have of course drawn attention to several drawbacks related to FPAs mark one, and that will touch upon just a few of them. So the current approach of monetary policy, the current approaches of the monetary policy, and therefore the communication strategies critically Hinge on the ability of the central bank
00:14:57 - Now, that is a problem because we can easily see that it, it is essentially impossible to make a forecast in times of critical uncertainty. So moreover, dropping such projections in the close of assurance and confidence has the potential to mislead both policy makers and economic agents by providing this false sense of security when we are planning at the same time
00:15:28 - to it, projections, the mismatch between baseline projections and what, what actually materializes can have very real impact on credibility as we were discussing in the case of 2021. Finally relying on baseline single forecast that's, somehow a narrow vision, how risks will materialize and what will happen in the future can create huge problems in terms of policy agility

Rethinking Model Dependency in Monetary Policy

00:15:59 - So, another thing that we have noticed and I would like to highlight is that FPA mark one has a tendency to be a model centric approach to monetary policy analysis. Although models are very important component of, any solid framework, I have nothing against, solid approach to that. But we do have a rule at the central bank and the rule is that our economist never say model says,
00:16:30 - They can use models as tools, but that that would be the economist own judgment. So, the greatest issue that we see here is that, over dependency on models and their outputs rather than underlying economics or quality of the e economists running the models and conducting analysis is, is a real problem. So we decided that we need to equip our own economists with tools necessary,
00:17:03 - economic judgment behind everything. And probably you remember what Stanley Fisher said about Bob Solo is, do you know that phrase he used during one of his set? He said, I would rather have Bob solo than an econometric model, but I would rather have Bob solo with an econometric model than without one. So that would be my short answer. So our robust communication framework is arguably the most important aspect of this new framework. So we'll put a lot of emphasis on communication, so
00:17:35 - our framework is first and foremost built upon the need of transparently clearly and effectively convey to our key stakeholders how the central bank is thinking about key sources of risk and uncertainty. Using this idea as our main motivator, we built a comprehensive framework for communications, transparency, accountability, which seek to achieve, probably six fundamental principles. Principle number one would be to provide clarity
00:18:08 - Number two, offer transparency about decision making process itself. Three would be ensure policy agility in the face of risk, uncertainty and dynamically evolving economic conditions. Fourth, provide markets and stakeholders with a combination of qualitative and quantitative forward guidance. Number five, support and strengthen central bank credibility. And number six, provide full transparency about analytics
00:18:40 - to conduct the analysis and the support of its own decisions to achieve this principles. we recognize that we have numerous different groups of stakeholders that serve as our target audiences in our communication. I think those group would include the general public first and foremost, but also medium journalists, financial markets specialist, academia, government ifi and so on. So of course the target audience for monetary policy communications I di are very diverse

Enhancing Economic Literacy and Transparency

00:19:11 - So which means that we need to work, also on economic literacy for the general public, which is from our perspective is providing the social or public good in that sense. But at the same time we have different approaches for different layers and groups how to communicate. So under FPA mark two, we place a very high degree of emphasis on being highly transparent about how we're thinking about the economy and how we arrive to our decision.
00:19:44 - minutes of the deliberation that led the board's decision on the same day as decision itself is published. We never did that before. This allows our stakeholders to understand in almost real time the dynamic surrounding in the key policy relevant issues. We'll be publishing attributed votes as well and the individual submissions of each and single board member. This means that readers will get to see
00:20:15 - that motivated each board member and thus have a much richer, more transparent and more comprehensive understanding of what the key issues which are driving our decision. But at this point I think we need to have systematic attention to policy risks and uncertainties. So the primary challenge facing the central bank is the inadequate inadequacy in terms of existing policy framework. So we think that we should be leading that, that work. The
00:20:51 - So we need to have a people of that caliber who would use analytical tools but at the same time would come to us and tell us the narratives as well. So that is, that is a very com very nice combination of skills which we're working on with, with our own people. Then the third will be probably investing in Ali analytical framework and model models themselves. So making them better, to include
00:21:21 - but also something which is much more complicated. Fourth will be probably transparency and accountability in terms of us being accountable to our general public. And, throughout you you see the red line and the way of thinking from our side is that our public good is to provide people with as much information so they understand better how we make decisions. And probably related to
00:22:10 - because by providing that impetus, we're also building, financial literacy blocks within the society, which probably would help to build credibility with us. And having people believing in central bank's policy probably would be the best reward that we can accept, like expect the trophy of the day.

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