Fan charts mitigate de-anchoring of inflation expectations
A new Bank of England working paper finds that communicating forecast uncertainty via fan charts helps stabilize public inflation expectations. The experimental study demonstrates fan charts mitigate the de-anchoring of expectations following forecast errors.
Fan charts: The uncertainty shield
A new Bank of England working paper examines how central banks can effectively communicate forecast uncertainty through visual media.
Part I of their experimental study tested various formats, including fan charts, dot plots, and speedometers, with both general public and expert audiences.
Findings indicate that fan charts are well understood and perform best at jointly conveying both expectations and uncertainty.
Part II implemented a novel dynamic information experiment with 1,600 UK participants.
This experiment revealed that while point forecasts initially anchor expectations marginally more, forecast errors significantly de-anchor expectations, particularly for 'unlucky' errors moving inflation away from target.
Critically, fan charts materially mitigate this de-anchoring, acting as an 'insurance policy' that helps protect central bank reputation.
This mechanism helps preserve forecaster credibility after misses and prepares audiences for inevitable mistakes.
The study also documents that communicating uncertainty via fan charts helps the public learn more realistic uncertainty perceptions, especially with wider fan charts, bringing subjective distributions closer to reasonable benchmarks.
The dynamic trade-off of transparency
The paper conceptualises uncertainty communication as involving a dynamic trade-off.
While it may weaken immediate anchoring by raising the salience of forecast error risk, it can also enhance understanding and protect credibility over time by preparing audiences for inevitable mistakes.
This question has gained urgency following the Bernanke Review of the Bank of England's forecasting processes, which recommended discontinuing fan charts while emphasising the continued importance of communicating forecast uncertainty.
The study addresses this gap by asking how central banks should communicate uncertainty and what the effects are.
It also highlights that the public consistently underestimates the degree of uncertainty in inflation forecasts, exhibiting substantial overconfidence in their point predictions.
Fan charts are shown to help correct this overconfidence.
Clarity in an uncertain world
This study provides crucial empirical evidence for central banks navigating the complexities of public communication in volatile economic times.
It strongly validates fan charts as a robust tool for managing public expectations, offering an 'insurance policy' against reputational damage from inevitable forecast errors.
The findings underscore the long-term benefits of transparent uncertainty communication over a narrow focus on short-term anchoring, improving public understanding and decision-making.