Moral Suasion

What is Moral Suasion?

The term “moral suasion” refers to the usage of rhetorical appeals, implicit threats, and persuasion in order to get a person or a group of people to change their behavior. Thus, moral suasion relies on verbal techniques rather than the use of force or coercion to get people to act in a certain manner. In economics, the term is used with respect to the activities of central banks.

What is Suasion?

A central bank may use tactics of moral suasion in public or private. The intent behind it may not always be altruistic in nature, which is why, in the economic realm, the term used is simply “suasion.”

Though several tools are available to policymakers, they aren’t always usable. In a situation where a central bank finds itself unable to enact a certain policy measure or prefers not to take explicit action, it may resort to suasion.

When is Moral Suasion Used?

A period of expansionary monetary policy is characterized by low interest rates. While a low interest rate regime may allow for economic growth, it comes with a drawback. The central bank is provided with little to no room to enact policy measures to meet its inflation goals.

It is because in a near zero-interest rate regime, as from December 2008 to December 2015, there is no way for the central bank to cut rates further. Since the size of its balance sheet also increases due to expansionary policy, purchasing more government debt also becomes extremely difficult.

Thus, even though the central bank is left with little influence on the market in terms of monetary policy tools, it must convince the market otherwise. It is because if the market thinks that a central bank is not in control of the economy, it can lead to a run on the dollar and an overall crisis.

A central bank convinces the public of its willingness – and ability – to support economic recovery in the future using tactics of suasion. For example, the minutes of a central bank’s monetary policy review meeting may be framed in a way that signals such a fact. Journalists and analysts then pick it apart and communicate it to the market.

Jawboning

In the U.S., when policymakers at the Federal Reserve enact such tactics, it is commonly known as “jawboning,” For example, the Fed can employ Open Market Operations (OMOs) to influence the rate of inflation.

However, it can also try to do so without the use of OMOs, more specifically, by using verbal gestures to imply certain ideas about their future plans regarding the market. It is termed in economic and business circles as an “open mouth operation.”

Practical Examples of Moral Suasion

In 1998, the Asian Financial Crisis dealt a huge set back to LTCM, a highly successful but highly leveraged hedge fund. A majority of the lenders of LTCM were large banks on Wall Street. The creditors could assume a huge amount of non-performing assets on their books if LTCM failed.

The Federal Reserve found itself unable to directly fund a bailout of the hedge fund, especially because using taxpayer dollars for the bailout would upset the general populace. Thus, the Fed resorted to coordinating a bailout package for the company. They succeeded in creating the impression that the company was too big to fail, and in the end, around 14 banks bailed out the company for $3.6 billion.

The fund was liquidated two years later, and while the Federal Reserve was still criticized for its role in the bailout, it was better than direct intervention.

Tactics of moral suasion are also commonly used outside. For example, during the Greek eurozone crisis, the president of the European Central Bank said in public that the banks were prepared to do “whatever it takes” in order to preserve the stability of the euro.

More Resources

CFI is the official provider of the global Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:

• Fiscal Policy
• Inflation Targeting
• Bandwagon Effect
• Prospect Theory
• See all management & strategy resources