Discussion by Øistein Røisland Norges Bank

1. Central Bank Decision-making and Communication under Uncertaintyby Sheila Dow, Matthias Klaes, David Mayes and Alberto Montagnoli Discussion by Øistein Røisland Norges Bank The Central Bank Communication, Decision-Making and Governance conference Wilfrid Laurier University, April 2009

2. Issue of the paper • Uncertainty, decision-making and communication … and therelationshipbetweenthese Three parts: • Theoreticaldiscussion • Descriptionofvariousapproaches to building a data setonhowcentral bank communicateuncertainty • Focusonsemantic data • Estimationoftherelationships

3. Why the research project is interesting and important • Offers somenewperspectivesonuncertainty and collectivedecision-making • Limited researchonthiskindofsemantic data • Tests someinterestinghypotheses • A change in the policy rate is associatedwith (i) highweightof argument (highconfidence) (ii) unaminityof opinion withinthe MPC • A ’nochange’ could be due to either • highweightof argument, butconflictingviewsamong MPC members • action • lowweightof argument (lowconfidence) • inaction

4. General comments • The theoreticaldiscussioncontainsmuchfood for thought • …butthefood is not veryeasy to digest • Assumptions and definitionscould be more precise • Specify a formal model? • The distinctionbetween ’risk’ and ’uncertainty’ central in thetheoreticaldiscussion • Is thisreally an importantdistinction for the purpose ofthepaper? • Do central bankers use ’risk’ and ’uncertainty’ in the same way as in thetheoreticalliterature? Page 5: ”Wearethereforedrawing a distinctionbetweenuncertainty and risk, where risk is taken to be quantifiable. The possibilitythattheseconceptsareconfused by monetary policy makers will be consideredbelow.” • Sounds promising, but not followed up

5. Risk and uncertainty Milton Friedman (1976): “In his seminal work, Frank Knight drew a sharp distinction between risk, as referring to events subject to a known or knowable probability distribution and uncertainty, as referring to events for which it was not possible to specify numerical probabilities. I have not referred to this distinction because I do not believe it is valid. […] We may treat people as if they assigned numerical probabilities to every conceivable event.” LeRoy and Singell (JPE, 1987): “[…] the received interpretation of Knight's classic risk-uncertainty distinction - as concerning whether or not agents have subjective probabilities - constitutes a misreading of Knight. On the contrary, Knight shared the modern view that agents can be assumed always to act as if they have subjective probabilities.“

6. How do monetary policymakers usethewords ’risk’ and ’uncertainty’? • Not thedistinctionnormallyattributed to Knight • My view: ”Risk” is often used whenthesubjectiveprobabilitydistribution is asymmetric, or thecostsof positive versus negative shocksareasymmetric • ”Risk ofdeflation”, ”risk ofovershootingtheinflation target”, ”risk of a systemiccrisis” etc • ”Balanced risk” meanssymmetricprobabilitydistribution or symmetriccosts • ”Uncertainty” does not necessarilymeanKnightianuncertainty • Both risk and uncertaintycan be used in a probabilisticviewofthe world • I don’tbelievethat ”theseconceptsareconfused by monetary policy makers” • They just usethemthe same way most peopleusethem! • Becauseofthedifferentmeaningof ”risk” by theauthors and thecentral banks, it is difficult to relatetheempiricalresults (usingwordcounts) to thetheoreticaldiscussion

7. Uncertainty and (in-)action • Is uncertaintyassociatedwithinaction? • Dependsonthe risk • Example: Norges Bank’s 50 basis pointcut, October 2008: There is now unusually high uncertainty surrounding economic developments ahead. It is difficult to provide an indication of the likelihood of different outcomes. In such decision-making situations, it may be appropriate to implement measures that can reduce the uncertainty and stave off a particularly adverse outcome for the economy. This now implies a more active monetary policy than normal, both in interest rate setting and through liquidity policy measures.”

8. Uncertainty and (in-)action, cont’d • What is inaction? • Inaction may not always mean keeping the interest rate unchanged • Depends on the strategy (if there is any) • For central banks with endogenous interest rate paths (Norway, Sweden, New Zealand, etc), ’inaction’ would probably mean ”stick to the plan” (which could mean a rate change) • Other central banks (Fed, ECB, etc) may also sometimes have a plan for future interest rates • Cf. the Fed’s ”measured pace”

9. Uncertainty and dispertion • Uncertainty ≠> variety of opinions • DKMM: Can be variety of opinions with high uncertainty, but also with high confidence • Claussen, Matsen, Røisland and Torvik (2009): • Disagreement can be a result of overconfidence • With correct perception of own and other committee members’ quality of judgements, and no communication frictions, there will be full agreement after the deliberation round

10. Conclusion and suggestion • Interestingtheoreticaldiscussion, butcouldtry to formalise thetheory • Somewhatdifficult to followtheauthors’ reasoning • Canthehypotheses be basedon formal models? • I think YES • I think it is possible to get far with a probabilisticapproach • Not clearhowKnightian (Keynesian) uncertaintychangetheresults • In practice, policymakers’ viewonuncertainty has elements ofbothKnightian and Bayesianuncertainty (risk). Buteasier to moder the latter. • Necessaryingredients in a formal model: • Imperfectknowledge • Differences in individualjudgements • An aggregationrule (e.g., majorityvoting) • A (fixed) costofchangingtheinterest rate • or anothermotivation for changingthe rate in discretesteps (e.g., 25 basis points) • In standard models, the MPC willalwayschangetheinterest rate, butsometimesverylittle • Possiblecandidate to start out from: Gerlach-Kristen (JEDC, 2008) • Add alternative assumptionsaboutsubjectiveconfidence (as in Claussen et al. 2009) • Simulatethemodel under differentassumptionsaboutthevarianceofindividualjudgements and theindividuals’ subjectiveconfidence • Show numericalresults and confronttheresultswiththeempiricalresults