Gauging Market Responses to Monetary Policy Communication

Abstract

The modern model of central bank communication suggests that central bankers prefer to err on the side of saying too much rather than too little. The reason is that most central bankers believe that clear and concise communication of monetary policy helps achieve their goals. For the Federal Reserve, this means to achieve its goals of price stability, maximum employment, and stable long-term interest rates. This article examines the various dimensions of Fed communication with the public and financial markets and how Fed communication with the public has evolved over time. We use daily and intraday data to document how Fed communication affects key financial market variables. We find that Fed communication is associated with changes in prices of financial market instruments such as Treasury securities and equity prices. However, this effect varies by type of communication, by type of instrument, and by who is doing the speaking.

KEYNES: Arising from Professor Gregory's questions, is it a practice of the Bank of England never to explain what its policy is?

HARVEY: Well, I think it has been our practice to leave our actions to explain our policy.

KEYNES: Or the reasons for its policy?

HARVEY: It is a dangerous thing to start to give reasons.

KEYNES: Or to defend itself against criticism?

HARVEY: As regards criticism, I am afraid, though the Committee may not all agree, we do not admit there is a need for defence; to defend ourselves is somewhat akin to a lady starting to defend her virtue.

Exchange between John Maynard Keynes and Bank of England Deputy Governor Sir Ernest Harvey, December 5, 1929.

Introduction

Central bank communication has come a long way since the Bank of England's motto ostensibly was "Never explain, never apologize." Today, the motto of central bankers might instead be "Can you hear me now?" The modern model of central bank communication suggests that central bankers prefer to err on the side of saying too much rather than too little. In this vein, central bank communication takes many forms, from economic forecasts and official reports, to speeches, interviews, testimonies before governmental bodies, and policy statements and press conferences immediately after policy meetings. In the United States, enhancements in central bank communication are most pronounced in the realm of speeches and other remarks (e.g., television interviews) by Federal Reserve (hereafter, Fed) governors and Reserve Bank presidents. These forms of communication have become more prominent since the recession and Financial Crisis. In an era of increased communication by Federal Open Market Committee (FOMC) participants, one may ask whether additional information is useful for financial market participants who carefully monitor monetary policy developments. Indeed, some economists and analysts have argued that Fed officials talk too much. There are many nuances to this argument, but the primary claim is that more information increases the probability of market mispricing. Shin (2017) discusses some of these issues.

There are at least two counterarguments to the market mispricing view. The first, as enunciated by Kocherlakota (2017), is that the price of an independent central bank is a set of independent voices to insure against group think. The second counterargument is that the pricing of financial instruments in markets is more efficient with more, not less, information. Regardless, central bank communication is important because individuals' economic decisions are based on expectations of future policies. Thus, clear communication of its policies and actions may help the Fed achieve its mandated goals of stable prices, maximum employment, and moderate long-term interest rates.

The purpose of this article is twofold. The first part examines the various dimensions of Fed communication with the public and financial markets. This includes documenting how communication with the public has evolved over time. The second part empirically analyzes the economic effects of Fed communication on key financial market variables. Our analysis uses daily and intraday data. We find that Fed communication can affect prices of financial market instruments such as equities and Treasury securities. However, this effect varies by type of communication, by type of instrument, and by who is doing the speaking. We also find that larger financial market reactions tend to be associated with communication from the Fed Chair, non-Chair Fed governors, and FOMC meetings without an associated press conference. We further find that financial market reactions following press conferences after FOMC meeting statements are not significant.