Professor of Economics; Academic Director, AQR Asset Management Institute
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Like motherhood and apple pie, transparency sounds like one of those things you can’t possibly object to. Honesty, openness, candour: surely, these are qualities we all admire and which we would like to see infuse every aspect of public life. Transparency is good.
If only things were quite that straightforward. Transparency should be a fundamental requirement for the efficient operation of markets: all participants are assumed to have access to the same information; and as a general principle, the more information the better. If I am weighing up whether to buy shares in a particular company, for example, I expect to know the price at which others are buying. Armed with that information, I know whether the person on the other side of the deal – the seller – is trying to rip me off by asking for a price higher than others are paying.
So far, so simple. But consider a particular case. Imagine that Italy is auctioning government bonds. I am an investment bank, I enter that auction and I end up buying a large chunk of the issue. I am not buying with the aim of holding the securities forever: I buy with the intention of off-loading them in smaller chunks to other investors. But if information about the auction were completely transparent and available to all, then others in the market would know that I am holding a big chunk of the bonds.
That would put me at a disadvantage, because the rest of the market would know that I have a big holding and want to get rid of it. I’m at a disadvantage: the price I’m likely to secure will be lower than if the market didn’t know the size of my holding. And step back a stage: if I believe that I risk being caught in that position with the market knowing how much I bought, I will feel more inhibited in bidding in the primary auction. So demand for the bonds will be less and the Italian government will receive a lower price for the issue.
How to deal with this, when one would think that the general principle of transparency should be the aim? This was considered carefully ahead of the introduction of MiFID – the Markets in Financial Instruments Directive that regulates investment services across the European Economic Area. Broadly, it was decided that there need be no disclosure of bids and offers ahead of an auction of government bonds. Information about trades should be made available after they had been made – but importantly, only after a delay. Transparency? Yes. But call it transparency lite. Or transparency postponed.
Take another example. Last year, an issue came up for consideration by the European Systemic Risk Board (ESRB), the EU’s macro-prudential authority where I sit on the General Board.
Staff flagged up concerns about the price of residential property in a number of countries - Austria, Belgium, Denmark, Finland, Luxembourg, the Netherlands, Sweden and the UK. In these places, the housing markets appeared to be in danger of overheating. And historically, housing market crashes are the single most important precursor of broader financial crises.
The Board agreed that letters should be sent to these countries to seek their views about their housing markets, asking what possible danger any overheating might present, and suggesting that they might consider appropriate macroprudential measures. That much was easy.
Rather more contentious was whether the letters should be published. This triggered a spirited debate.
The argument in favour of publication was pretty straightforward: why should the simple fact that the ESRB had flagged up a potential problem be kept from public view? Why not be transparent? People in the markets – banks, households and so on – should know about the regulator’s fear that prices were getting out of line. Market participants should have access to the maximum possible amount of information, and the views of authorities are part of that information. It was therefore wrong to withhold it.
The counter-argument ran along these lines: the very publication of the letters might itself contribute to the exactly the sort of sudden market movement about which the ESRB was concerned. Publication could force the hand of national regulators, which might itself have a direct impact on the market. And if buyers, sellers and lenders knew that the regulator was worried the market was overheating, that could have a potentially destabilising effect.
In the end, the transparency argument won – but there was no consensus.
So, it’s pretty obvious – transparently clear, one might say – that complete transparency is not always going to be universally welcomed and embraced. As a broad, guiding principle, it is attractive. But in particular circumstances, there are perfectly valid arguments against complete transparency. And nowhere is that more true than in setting monetary policy.
People who are responsible for setting monetary policy have to be able to justify what they say
Here, the arguments for and against transparency become decidedly ticklish. When the governing body of a central bank sets interest rates, just how much information should the world at large be given about why a decision was taken? If minutes of rate-setting meetings were to be published, how detailed should those minutes be?
Around the time that the European Central Bank (ECB) was being set up in 1998, this was a debate that, quite naturally, came very much to the fore. There was a key argument against detailed disclosure: if members of the governing council knew that their views would be made public, then they would be inhibited in what they said. In particular, individual members of the rate-setting committee would be reluctant to speak their minds at the ECB if they thought that the opinions they expressed could then be used to put them under political pressure in their own country.
After all, the fundamental idea of the ECB is that it is an authority for the whole Eurozone: the interests of a particular country should not dominate decision-making. Members of the governing council should be making choices that are good for the entire single currency area.
The ECB eventually got round this by publishing a record of discussions, but without identifying who said what. And given that there are so many members of the governing council – far more than the number on the equivalent committee of the US Federal Reserve - it is hard to link a particular point of view to an individual council member simply by studying what the minutes of meetings show.
But there is one very good argument in favour of transparency about central banks’ deliberations: it means that the people who are responsible for setting monetary policy have to be able to justify what they say. Imagine that a member of the US Federal Open Market Committee (FOMC) was travelling to a meeting. In the bad old days, he (and assume it was a he) could be content in the knowledge that there would be no published minutes of the meeting. His declared views, whether sagacious or stupid, would never be revealed to the world at large. So this notional board member could rely on a short briefing from one of his minions as he travelled to Washington for the FOMC meeting. That might be the sum total of his preparation, and his lack of groundwork would never be revealed to the world at large.
That’s no longer the case. For more than two decades, the FOMC minutes have given more detail, and importantly, show which way individuals vote on key decisions.
Is that a good thing? Personally, I have a bias towards transparency. Having full minutes means that people can be held to account. They can’t just wing it, having had a quick chat with one of their staff ahead of making a decision. Transparency – in this case, the knowledge that minutes of a meeting will be published – means that committee members will need to demand proper reports beforehand, full briefings on what they are meant to be addressing and advice on how to underpin whatever case they wish to make.
The pro-transparency argument wins: instead of being inhibited by disclosure, committee members make sure they are better prepared and make better-informed decisions.
Of course, arguably, there is a downside to transparency. The media, commentators and indeed market participants pounce on every utterance, however trivial, from members of bodies that set interest rates. If a member of the Bank of England’s Monetary Policy Committee gives an interview or makes a speech, every syllable is scrutinised, every phrase dissected, in an attempt to infer the most subtle clues about his or her view on which way interest rates are heading. Personally, I think this level of reporting and quasi-analysis is rather foolish. Certainly, central banks are happy if the markets’ expectations are broadly in line with those of the bank. But why devote so much time, energy and newspaper coverage to what someone said while taking little account of how much weight that individual’s views are likely to have when it comes to making a decision?
Does it cause damage? In terms of disruption of markets, probably not much. But it diverts attention away from much bigger economic issues that require urgent consideration.
Make no mistake, in most situations, transparency is a good thing. It is valuable. But sometime, like all valuable things, it needs rationing. We should be judicious in how we deploy it.
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