Central Bank Communication: Different Strategies, Same Effectiveness?

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1 Cenral Bank Communicaion: Differen Sraegies, Same Effeciveness? Michael Ehrmann and Marcel Frazscher * European Cenral Bank November 2004 Absrac The paper assesses he communicaion sraegies of he Federal Reserve, he Bank of England and he European Cenral Bank and heir effeciveness. Based on he conen, iming and consisency of saemens by he policy commiees and is individual members as well as he voing behaviour, we argue ha he hree cenral banks are following fundamenally differen communicaion sraegies, wih he Federal Reserve pursuing an approach ha sresses he individual accounabiliy of FOMC members, whereas he European Cenral Bank has been pursuing a more collegiae, and he Bank of England an inermediae approach. The cenral finding is ha he predicabiliy of policy decisions and he responsiveness of financial markes are equally good for he Federal Reserve and he ECB, hough here are imporan differences in he ype of communicaion ha financial markes reac o. This suggess ha here may no be a single bes approach o cenral bank communicaion, and ha he mos effecive way of communicaion depends on he circumsances and he environmen a cenral bank operaes in. JEL classificaion: E43, E52, E58, G12 Keywords: communicaion; moneary policy; effeciveness; sraegies; Federal Reserve; Bank of England; European Cenral Bank. * We would like o hank Terhi Jokipii for excellen research assisance, and Reuers, Sandard and Poor s and Rasmus Pilegaard for providing some of he daa series. We are also graeful o Nicolea Baini, Richhild Moessner, Robero Rigobon, Bob Telow, Bernhard Winkler and seminar paricipans a he ECB and FU Berlin for commens and discussions. This paper presens he auhors personal opinions and does no necessarily reflec he views of he European Cenral Bank.

2 [T]he willingness of FOMC members o presen heir individual perspecives in speeches and oher public forums provides he public wih useful informaion abou he diversiy of views and he balance of opinion on he Commiee. B. Bernanke (2004) Wha maers for ransparency is herefore clariy as well as openness. For a new and supranaional insiuion like he ECB, i is paricularly imporan ha i sends clear and coheren messages o he markes and he wider public. Speaking wih one voice or a leas speaking one language is of paricular imporance for ransparency and clariy in he case of he Eurosysem. O. Issing (1999, pp ) 1. Inroducion The pas decade has winessed a paradigm change in he way cenral banks around he world conduc moneary policy. This paradigm change has implied no only a change in he sraegy pursued by cenral banks, bu also in how cenral banks have implemened heir respecive sraegies. Apar from greaer independence, one key elemen in his process has been he move owards increased ransparency. Transparency, which may be defined as he absence of asymmeric informaion beween policy makers and he public, is an inegral par of accounabiliy required of independen cenral banks. Beyond is role in making a cenral bank accounable, here is a broad consensus ha ransparency may also help enhance he effeciveness of policy (Blinder 1998, Woodford 2003). In ha respec, however, he cenral bank is faced wih a poenial conflic, as a maximum level of ransparency need no be opimal for he efficiency wih which i is able o pursue is mandae. Such a conflic may occur when giving more informaion induces no more bu less clariy and common undersanding among marke paricipans, as here are limis o how much informaion can be digesed effecively (Kahnemann 2003). Moreover, oo much informaion may crowd ou he formaion of privae beliefs which are a crucial source of informaion for a cenral bank, and hus for he effeciveness of policy making (Amao, Morris and Shin 2002). As such, ransparency is no an end in iself bu merely a means o help he auhoriy achieve is mandae (Issing 1999, Mishkin 2004). A decisive facor in ha regard obviously lies in he way a cenral bank communicaes wih he public. In designing a communicaion sraegy, a cenral bank needs o ake ino accoun ha is decisions are generally aken by a commiee, and no by a single individual. The role of he individual s views in he communicaion sraegy does herefore need clarifying. I can eiher be desirable o communicae he diversiy of he views in he commiee, as argued by Bernanke in he above quoe, or he cenral bank migh hink ha his may risk inhibiing clariy and common 2

3 undersanding, as argued by Issing. In he firs insance, a more individualisic approach o communicaion is preferable, whereas in he second case, a cenral bank would op for a more collegiae approach. A similar choice has o be made for he decision-making process, where more or less consensus-building can be praciced. The objecive of his paper is o analyse he communicaion sraegies and o assess heir effeciveness for hree of he world s major cenral banks: he Federal Reserve since is adopion of a more ransparen disclosure pracice in May 1999, he Bank of England since is independence in May 1997, and he European Cenral Bank (ECB) since January We focus on wo cenral quesions. Firs, do communicaion sraegies in hese hree cenral banks differ and how? Second, we assess he effeciveness of communicaion by asking wheher communicaion helps financial markes beer anicipae moneary policy decisions and helps cenral banks in moving asse prices in he desired direcion. We find ha he hree cenral banks differ fundamenally in hese regards. All hree communicae wih he public on he one hand hrough saemens ha are made on behalf of he enire commiee (such as press releases on heir moneary policy decisions), and on he oher hand hrough he individual members of he decision-making bodies (e.g., hrough iner-meeing speeches, inerviews, ec.). However, he degree o which he diversiy of views is expressed in he laer differs significanly. We find ha he Federal Reserve is pursuing a more individualisic sraegy o communicaion as here is a high degree of dispersion in wha he individual members of he Federal Open Marke Commiee (FOMC) say. By conras, he Bank of England and he ECB have been following a more collegiae communicaion sraegy in ha he degree of consisency among he commiee members is significanly higher. Moreover, saemens by members of he ECB s Governing Council show he highes degree of consisency wih policy decisions as compared o he Bank of England s Moneary Policy Commiee (MPC) and in paricular he FOMC. Sark differences can also be observed in he approach o decision making. We invesigae he voing behaviour by he individual commiee members, which in iself may consiue an imporan source of informaion abou he diversiy of views in he commiee. We find ha he Bank of England s MPC exhibis a remarkably high degree of dispersion in voing, which sands in sharp conras o is collegiae approach o iner-meeing communicaion. By conras, he FOMC shows some, albei very low, degree of voing dispersion, wih few decisions no being made unanimously, while decisions in he Governing Council are generally made in a consensual way. As he final par of our analysis we urn o he quesion of how hese differences in sraegies impac he effeciveness of communicaion. We argue ha a collegiae approach o communicaion and decision-making as praciced by he ECB will lead o highly predicable policy decisions, and will imply ha markes reac o saemens by all policy-makers in he same fashion. An approach as followed by he Federal Reserve, where communicaion is dispersed, bu voing consensual, will make a cenral bank predicable if markes are able o figure ou whose saemens o wach closely 3

4 o. In his case, we should expec ha communicaion by some policy-makers is relaively more influenial han ha of heir peers. Finally, we argue ha an approach as followed by he Bank of England, where communicaion is collegiae, ye voing is highly dispersed, runs he risk of being less predicable, and migh imply ha financial markes do no reac o communicaion as srongly as for he oher cenral banks. As a maer of fac, we find ha he predicabiliy of policy decisions is highes for he FOMC and he Governing Council, and lower for he MPC. Also he reacion of financial markes o communicaion essenially confirms our hypoheses. US markes reac significanly sronger o saemens by Chairman Greenspan and less o saemens by oher FOMC members, whereas euro area markes respond o communicaion by he ECB Presiden and oher Governing Council members o a very similar exen. Moreover, US markes reac o saemens boh abou he moneary policy inclinaion and he economic oulook, whereas UK and euro area markes respond mosly only o communicaion abou moneary policy, a difference ha mos likely reflecs also he differen marke percepions of policy reacion funcions. We conclude ha he approaches o communicaion by he Federal Reserve and by he ECB have proven o be equally successful in heir effeciveness, despie having pursued very differen sraegies, suggesing ha here may no be a single bes approach o designing a cenral bank communicaion sraegy. The paper sars by reviewing he lieraure on cenral bank communicaion in secion 2. Secion 3 hen discusses our daa source. The communicaion sraegies of he hree cenral banks are analysed and compared in secion 4. This is followed by an empirical analysis of he effeciveness of cenral bank communicaion in influencing asse prices in he desired way in secion 5. Conclusions and policy implicaions follow in secion Lieraure on cenral bank communicaion The academic and policy lieraure on cenral bank communicaion sresses he seminal role of communicaion for he effeciveness of moneary policy (Bernanke 2004, Blinder 1998, Buier 1999, Issing 2004, King 1997). 1 Blinder (1998) and Bernanke (2004) emphasise ha moneary policy has in many counries only a single direc ool, namely he overnigh ineres rae, and hus ha moneary auhoriies can exer only an indirec effec on hose asse prices ha are of key imporance for he economy, such as long-erm ineres raes, equiy prices and exchange raes. Communicaion herefore provides an imporan means for cenral banks o influence hese asse prices, bu i requires credibiliy and a srong rack record for auhoriies o do so. Much of he academic lieraure focuses on he heoreical aspecs of ransparency and communicaion, frequenly building on he influenial work by Cukierman and Melzer (1986). 2 The definiion of wha consiues ransparency is no always sraighforward. Alhough i generally is 1 I may or may no be a coincidence ha all five of hese, a imes, have been influenial academics and policy makers. 4

5 undersood o mean he absence of asymmeric informaion beween markes and policy makers, here are differen elemens o ransparency including clariy, openness, honesy and common undersanding (Winkler 2000). A firs key issue in his lieraure is wheher and under wha condiions ransparency improves economic efficiency. LeRoy and Porer (1981) and Geraas (2002) show ha communicaion may be undesirable if i is of poor qualiy or sufficienly noisy so as o raise marke volailiy. A second srand of he lieraure focuses on he exen o which communicaion can subsiue policy acion. In principle, a moneary auhoriy ha is sufficienly credible may be able o influence asse prices by communicaing is views abou is inended level and by signalling is inenion o move policy if asse prices deviae from his arge. This issue has sparked a debae abou he ime consisency of such open mouh operaions, which implies ha auhoriies may have an incenive o give incorrec informaion o he markes and hus ha communicaion can be fully credible and effecive only if i is followed by policy acion. Much of he work in his area has focused on sraegic moneary policy games, building on he work by Kydland and Presco (1977), Barro and Gordon (1983) and Walsh (1998). For insance, Goodfriend (1986) and Sein (1989) argue ha one soluion o his rade-off problem beween mainaining credibiliy while conducing an effecive communicaion policy is o provide imprecise announcemens abou is views and informaion, i.e. by providing less han full ransparency. A hird srand of he lieraure has emerged more recenly ha shows how ransparency may aler he balance of he informaion exchange beween he moneary auhoriy and he markes in he opposie direcion of wha he second srand implies, namely by inducing a sub-opimal behaviour by financial markes. Morris and Shin (2002), Amao, Morris and Shin (2003) and Padoa-Schioppa (2004) argue ha communicaion by cenral banks may become oo dominan by crowding ou he formulaion of independen beliefs by he privae secor based on he informaion ha i has a comparaive advanage in gahering. Transparency and communicaion may hus be undesirable o he exen ha i eliminaes or a leas reduces an imporan source of informaion for he cenral bank, namely he marke perspecive as a disinc source of informaion, which plays an imporan role for moneary policy making. A fourh srand is sressing he imporance of he role and consiuion of he policy-seing commiee and insiuional facors governing he decision-making process. A broad consensus has emerged ha delegaing he moneary policy decision o an independen commiee of individuals leads o a superior policy for a number of possible reasons, such as he abiliy o pool judgmens of differen individuals (Blinder and Morgan 2000), abiliy o learn from oher members (Lombardelli, Proudman and Talbo 2002) or he increased flexibiliy ha commiees show in responding o shocks of differen magniudes (Siber 2003, Mihov and Siber 2004). However, he lieraure is sill 2 Geraas (2002) and Carpener (2004) provide a deailed review in paricular of he heoreical work on ransparency and communicaion. 5

6 in is infancy, as many issues such as hose relaed o he role of sraegic voing, he uncerain incenives of individuals o acquire and reveal privae informaion, possibly conflicing preferences and communicaion among members make i hard o provide a conclusive recommendaion of he role, size and consiuion of commiees (e.g. Gerling, Grüner, Kiel and Schule 2003). Concerning empirical work on cenral bank communicaion, he lieraure is sill quie small, parly reflecing he difficuly of measuring i and parly due o he relaively recen adopion of ransparency as a major characerisic of cenral bank policy. Guhrie and Wrigh (2000) find ha communicaion has been used in a sysemaic and highly effecive way for conrolling shor-erm raes by he Reserve Bank of New Zealand. For he Unied Saes, Kohn and Sack (2003) show ha saemens by FOMC Chairman Greenspan abou he moneary policy inclinaion has a significan effec on he volailiy of shor-erm ineres raes while saemens abou he economic oulook end o have a significan impac on longer mauriies. Demiralp and Jorda (2003) provide relaed evidence by showing ha i is mainly he public announcemens by he Fed ha move shor-erm ineres raes, raher han he liquidiy channel of open marke operaions. For he ECB, Gerlach (2004) analyses he conen of he ECB s Monhly Bullein in erms of inflaion, economic aciviy and money, and wheher hese are consisen wih moneary policy decisions. Finally, Bernanke, Reinhar and Sack (2004) and Gurkaynak, Sack and Swanson (2004) find ha US financial markes aribue considerable imporance o saemens ha include an indicaion abou he fuure pah of policy. Haldane and Read (2000) provide evidence ha he effec of moneary policy decisions on shorerm ineres raes in he Unied Kingdom has decreased over ime, which may sugges ha informaion asymmeries abou he economy have been reduced. Andersson, Dillen and Sellin (2001) for Swedish Riksbank and Siklos and Bohl (2003) for he Bundesbank before 1999 also find ha communicaion of hese wo cenral banks has indeed played some role in influencing financial markes. The laer show ha Bundesbank communicaion is more srongly relaed o financial marke movemens if hese saemens are abou ineres raes as compared o he exchange rae. Jansen and de Haan (2004b) look a he ECB in and argue ha saemens among he individual members of he Governing Council abou ineres raes and abou inflaion exhibied some degree of conradicion, hough his has decreased over ime. Finally, here has been some empirical work on he role of cenral bank communicaion in differen conexs. Jansen and de Haan (2004a) for he ECB and Frazscher (2004) for he G3 moneary auhoriies analyse he effec of communicaion on exchange raes. While he former finds some effec on he volailiy of he euro, he laer finds more sysemaic evidence in favour of effeciveness for all hree G3 cenral banks in changing he level and volailiy in he desired direcion. A differen srand of he empirical lieraure analyses how predicable moneary policy decisions of differen cenral banks are (Arus and Wyplosz 2002, Kuner 2001, Ehrmann and Frazscher 2003, 2004a, Lange, Sack and Whiesell 2003, Perez-Quiros and Sicilia 2002), alhough 6

7 in a companion paper we do no find ha he change in he Federal Reserve s disclosure pracice in May 1999 has improved he abiliy of markes o predic moneary policy decisions (Ehrmann and Frazscher 2004b). 3. Measuring communicaion We firs urn o he issue of how o measure communicaion. We wan o obain all saemens relaed o moneary policy by all relevan policy makers over he ime period of ineres. We disinguish beween wo caegories of communicaion. The firs caegory capures he saemens on meeing days by he moneary policy commiees he FOMC of he Federal Reserve, he MPC of he Bank of England and he Governing Council (GC) for he ECB. The FOMC releases a saemen ha includes a balance-of-risks assessmen abou risks o inflaion and he economic oulook on he FOMC meeing day, and he meeing minues abou six weeks laer. 3 The ECB issues a press saemen and holds a press conference afer Governing Council meeings. The Bank for England, by conras, releases only a brief informaion abou is policy decision on he meeing day and hen issues he minues of he meeing wih abou a wo-week delay. The second caegory of communicaion by cenral banks is ha of is commiee members in he iner-meeing period. For he policy makers, we include he FOMC s 19 members, comprising he seven governors of he Board of Governors or wha we refer o as inernal members and he 12 presidens of he Federal Reserve Banks ( exernal members). We do no make a disincion beween voing member and non-voing members as all 19 members paricipae in he FOMC meeings. 4 For he MPC, we cover he governor, he oher four inernal members and he four exernal members, who are appoined direcly by he Chancellor of he Exchequer. For he Governing Council of he ECB, we cover he 6 Execuive Board members ( inernal members), including he Presiden, and he 12 governors of he naional cenral banks (NCBs) of he Eurosysem ( exernal members). As for he ime period over which we analyse he communicaion policies of hese hree cenral banks, we use daily daa for all daa series and begin he analysis in May 1999 for he Federal Reserve, as i hen underwen significan changes in is disclosure pracices and ransparency. We chose he period since May 1997 for he Bank of England as a ha poin i was graned independence, and January 1999 for he ECB for he sar of is conduc of moneary policy. Having deermined he policy makers and respecive ime periods, we use a commonly used newswire service, Reuers News, o exrac all repors abou forward-looking policy saemens, 3 See Federal Reserve (1999, 2000) for a formal accoun, and Poole (2003), Poole and Rasche (2003) and a companion paper o he presen one (Ehrmann and Frazscher 2004b) for a more deailed discussion and assessmen of he effec of releasing a balance-of-risks assessmen. 4 The 12 voing members of he FOMC comprise he seven governors and five of he 12 presidens of he Federal Reserve Banks. The Presiden of he Federal Reserve Bank of New York has a permanen voe, he presidens of he Chicago and Cleveland branches alernae annually while he oher nine presidens roae on a hree-year basis. 7

8 which can be hree ypes of communicaion - speeches, inerviews or esimonies, on a daily basis. We disinguish beween wo ypes of saemens, one referring o he moneary policy inclinaion, and he second one o he economic oulook. Clearly, one can hink of differen and finer caegories of communicaion, such as e.g. disinguishing also beween saemens abou inflaion versus moneary aggregaes. However, we decided o keep he caegorisaion as simple as possible, following he erminology also used by Kohn and Sack (2003). The search commands we employed are he name of he policy maker ogeher wih he erms ineres raes or moneary policy for he firs ype of saemens, and ogeher wih economy or economic oulook for he second ype o exrac all relevan saemens. The objecive is o obain all saemens in real ime, i.e. on he day and ime when hey occur in order o be able o es wheher hese saemens influence financial markes. In paricular, we very carefully chose only he firs repor in Reuers News, which usually comes wihin minues of each saemen and is mosly descripive wihou providing much analysis or inerpreaion, and discard all subsequen repors or analysis of he same saemen. Furhermore, as much as possible, we argeed only forward-looking saemens, as opposed o saemens ha aim o explain o he markes he mos recen decision ha had been aken a he ime. This allows us o preven duplicaion as well as o avoid including repors ha occur someimes wih a delay of some days. For he communicaion of he commiees on he meeing days, we look direcly a he released maerial, as discussed above. The final sep consiss of classifying he iner-meeing saemens ino hose ha give an inclinaion of igher moneary policy versus no change or lower ineres raes (C MP ), 5 and accordingly for he economic oulook (C EC ): C EC = sronger econ. oulook unchanged econ. oulook weaker econ. oulook C MP = ighening inclinaion no inclinaion easing inclinaion The same classificaion is underaken for he communicaion on meeing days (M EC, M MP ), which for he FOMC is simply he bias of he balance-of-risks assessmen, and for he ECB is based on he inroducory saemen. An imporan poin o sress is ha his classificaion is based on our own judgmen and reading of he newswire repors and hus does no rule ou a wrong classificaion in individual cases. In hose 8

9 cases where we were unsure abou he classificaion of he saemen, we double-checked subsequen repors abou he same saemen and classified hem accordingly. Four addiional caveas of he mehodology should be emphasised. Firs, newswire services are selecive in heir reporing, hus no covering all saemens made by all he relevan commiee members, alhough he large majoriy of saemens are indeed repored. However, as we are ineresed parly in esing he marke response o communicaion, i makes sense o focus only on hose saemens ha acually reach marke paricipans, and his is bes achieved by looking a a prominen newswire services. Second, newswire services may wrongly repor or misinerpre a saemen by policy makers. Third, communicaion may have an undesired effec on markes, wheher i is correcly or incorrecly repored. Again, our objecive is o assess communicaion from he perspecive of financial markes and herefore we analyse he informaion marke paricipans acually receive. And fourh, many differen pieces of news hi and influence financial markes every day. To ensure ha we are measuring he effec of communicaion, raher han ohers news, we esed wheher imporan macroeconomic news played a role bu did no find significanly differen resuls from hose repored below. 4. Sraegies of communicaion Our firs objecive is o undersand and compare he communicaion sraegies by he hree cenral banks. By communicaion sraegy we mean and focus on hree aspecs: firs, he conen wha is being communicaed and by whom second, he iming wheher here is a sysemaic paern o when communicaion occurs, in paricular wih regard o meeings and moneary policy changes and hird, he consisency wheher he conen of he communicaion among he differen members of he commiee are consisen wih one anoher and wih moneary policy decisions. 4.1 Communicaion in he iner-meeing period Conen Who alks and wha is being said in he iner-meeing period? Table 1 provides an overview of all saemens exraced from Reuers News using he approach discussed above. Some ineresing sylised facs emerge from his overview. Firs, here are many saemens ha are neural abou he moneary policy inclinaion, and his is in paricular so for members of he Governing Council he ECB. In fac, a very ofen repored language of Governing Council members refers o ineres raes and moneary policy in he euro area as being appropriae, or wha we label neural in Table 1. Overall, 142 or 62% of all ECB saemens abou moneary policy were neural. By conras, FOMC members seem o be more inclined o provide a view of changes in moneary policy. Only 46 or 28% of he saemens by 5 A similar mehodology for he classificaion of moneary policy saemens is used by Guhrie and Wrigh (2000) for New Zealand. 9

10 FOMC members were neural, while 41% of saemens by MPC members abou moneary policy inclinaion were neural. Moreover, relaively more biased saemens are owards easing han ighening, which makes sense as ineres raes wen down for mos of he period in he sample. Second, communicaion abou he economic oulook mosly indicaes an improvemen in he economic oulook, wih hardly any saemens indicaing no change. This may seem somewha a odds wih he facs of booming economies ill 2000, a sharp slowdown hereafer and a mosly modes recovery since However, he resuls make sense considering ha a saemen indicaing no change in he economic oulook may conain lile news whereas a neural saemen abou moneary policy does and herefore policy makers may refrain from making such saemens. Table 1 here Third, he head of each cenral bank generally communicaes more han oher commiee members. This is he case in paricular for he Federal Reserve and he Bank of England, bu less so for he ECB. Wha is also sriking abou he saemens of he heads of he hree cenral banks is ha hey make relaively fewer neural saemens han oher members. This may be inerpreed as he heads leading he communicaion sraegy in indicaing he commiee s views on moneary policy and is changes. Moreover, here is again a difference across he differen cenral banks as his poin applies in paricular o he Federal Reserve, and much less so for he ECB, wih he Bank of England ranging in beween. Fourh, here is a difference in he way inernal commiee members and exernal members communicae. Exernal members provide a larger number of saemens han inernal members when excluding he head for he Federal Reserve and he ECB, which reflecs he fac ha he group of exernal members is significanly larger han ha of he inernal members wihou he governor. However, an ineresing difference is ha exernal members seem o provide biased saemens, i.e. indicaing ighening or easing of moneary policy, relaively more ofen han inernal members. In sum, hese sylised facs offer some sriking differences in he communicaion of he hree cenral banks. We invesigae in deail below wheher his finding is explained by he differen pahs in moneary policy or raher reflec differences in communicaion sraegies Timing Is here are purposeful sraegy behind he iming of communicaion? One objecive of communicaion is o prepare markes of upcoming policy decisions. I may herefore be possible ha policy makers inensify communicaion prior o meeings, or a leas o meeings in which a change is envisaged o be likely or expeced by he markes. Alernaively, some observers have 10

11 argued ha policy makers may choose o communicae less jus before meeings in order no o raise marke uncerainy. Figures 1.a 1.c provide an overview of he disribuion of saemens abou he moneary policy inclinaion and he economic oulook over he whole period of or The figures underline some of he poins sressed above abou he conen of he communicaion, bu hey also show some marked differences in he direcion and frequency of communicaion across differen sub-periods. In paricular, he saemens abou moneary policy are largely consisen wih he direcion of he moneary policy rae and communicaion inensifies in periods of change. Specifically he years 2001 and 2002 sand ou, underlining he significan changes in moneary policy and he economic oulook aking place during hose wo years. Figures 1.a-1.c here Focusing in more deail on he iming of communicaion around moneary policy meeings, Figures 2.a 2.c show he disribuion of saemens on he days before and afer he policy meeings of he hree auhoriies. There is one sriking similariy across all cenral banks: in he days immediaely prior o he moneary policy meeings, here is a considerably smaller amoun of communicaion compared o oher days. Furhermore, he inensiy of communicaion is differen before meeings han afer meeings for all hree cenral banks. Wih he excepion of he days surrounding he moneary policy meeings, here is generally a higher level of aciviy before han afer meeings, sressing he aemp of cenral banks o prepare markes for he upcoming meeing. Figures 2.a-2.c here On anoher dimension, he ECB differs from he Federal Reserve and he Bank of England. In he case of he FOMC and he MPC, i generally holds ha, he furher away from meeings, he more communicaion akes place. In he case of he ECB, he peak in communicaion is relaively close o he upcoming Governing Council meeings, namely hree and four days in advance. Accordingly, he ECB shows he sharpes drop in communicaion aciviy jus prior o he meeings. 6 A formal es of he hypohesis ha cenral banks inensify communicaion prior o meeings in which a change is envisaged o be likely is provided in able 2. For each cenral bank, he able compares he frequency of communicaion in he iner-meeing periods ha precede meeings wih and wihou ineres rae changes. The frequency is calculaed as he share of days in which communicaion akes place. I urns ou ha he difference is saisically significan for he Federal 6 Anoher difference ha is concealed hrough he aggregaion of several days ino one bar consiss in he behaviour on he individual days prior o he moneary policy meeings. Communicaion aciviy picks up slighly on days 3 o 1 compared o day 4 in he case of he Bank of England and compared o days 7 o 4 for he Federal Reserve, a paern ha is no observed for he ECB. 11

12 Reserve a he 99% level, and for he Bank of England a he 90% level. Boh cenral banks do indeed inensify communicaion prior o meeings in which ineres raes are changed. This is no he case for he ECB, however, which has virually idenical frequencies for boh occasions. Table 2 here Consisency As he final sep in he analysis of he communicaion sraegy of he hree cenral banks, we urn o he issue of consisency: are he saemens of he individual commiee members consisen wih each oher and wih moneary policy decisions? Looking a his issue may allow us o obain a beer undersanding on wheher here are differences in he way he role of communicaion is undersood and defined by he hree auhoriies. We use a simple saisical dispersion measure o assess he consisency of communicaion in he period beween meeings for each of he cenral banks. This dispersion for a paricular iner-meeing period k is defined as he sum of he disance beween each of he saemens in he iner-meeing period divided by he maximum oal disance: Ω MP k = N 1 N i= 1 j= i C MP i 2 ( N D) C MP j (1) wih C MP defined as a [-1,0,+1] variable, as oulined above, N he oal number of saemens in he iner-meeing period k, and D a dummy ha akes he value of one if N is an odd number and zero if i is even. 7 The oal dispersion measure Ω over all iner-meeing periods is he defined as he average of he individual dispersion measures Ω k : Ω MP = K k = 1 Ω K MP k (2) The dispersion measure for communicaion abou he economic oulook is defined analogously. 8 7 The reason for changing he weighing for he periods wih an odd number of saemens is ha he las observaion in he odd-numbered case may provide no addiional informaion abou he degree of dispersion. As an example, ake he case of wo saemens one being neural and one indicaing a ighening bias which yields a disance measure of Ω k = (1-0) / 0.5 * 2 2 = 0.5. If here is a hird saemen i should no aler he degree of dispersion wheher i is neural or has a ighening bias. Hence, he dispersion measure in eiher case also yields Ω k = [(1-0)+(1-0)] / 0.5 * (3 2-1) = 0.5, which is achieved by adjusing he denominaor. 8 The dispersion measure is also used by Jansen and de Haan (2004), who use differen communicaion daa and focus only on he ECB and Bundesbank officials in

13 Figures 3.a 3.c show he disribuion of he dispersion measures over ime, disinguishing beween moneary policy inclinaion in he upper panel and he economic oulook in he lower one. The figures show dispersion in communicaion hroughou he period, hough for many cases here is an increase in dispersion in 2001 and 2002, when here were relaively many moneary policy changes and an increased degree of uncerainy abou he prospecs of he hree economies. Figures 3.a-3.c here Panel A of Table 3 shows he average dispersion for each of he cenral banks and gives es resuls for wheher here are saisically significan differences in dispersion across cenral banks. Dispersion of communicaion abou moneary policy for he Federal Reserve is 0.32, and significanly lower a 0.13 for he Bank of England and 0.15 for he ECB. This resul is imporan as i suggess ha communicaion abou moneary policy among he members of he FOMC is less coordinaed and may pursue a differen objecive from ha of he members of he Governing Council and he Moneary Policy Commiee. The resul may also parly reflec he fewer saemens by and fewer members of he MPC as shown also in Table 1 and he fac ha he ECB and he Bank of England have more frequen policy meeings. 9 The role ha he number of commiee members may play in deermining he degree of dispersion is addressed in panel B of Table 3. This able shows he degree of dispersion in communicaion among a single commiee member, namely he head of each cenral bank. The resuls show a very low degree of dispersion for each of he heads. Overall, wha his suggess is ha he degree of dispersion presened in panel A of Table 3 reflecs he dispersion across commiee members. We also inerpre his evidence as supporing he qualiy of our communicaions daa as one would indeed expec a low degree of dispersion for individual members. Table 3 here Taking a differen perspecive, a complemenary way of assessing he consisency of communicaion is o ask wheher saemens are consisen wih he decision aken in he nex meeing or in fuure meeings. Panel A of Table 4 shows he share of all saemens ha is consisen wih he nex moneary policy decision. The key finding is ha 68% of all saemens abou he 9 Scheduled FOMC meeings occur eigh imes, or abou every six weeks, whereas MPC meeings and Governing Council meeings a which moneary policy is discussed usually ake place once a monh. Before November 2001, moneary policy was discussed in each of he bi-weekly meeings of he ECB Governing Council. As a longer iner-meeing period means ha more informaion becomes available and hence he moneary policy inclinaion and economic oulook is more likely o change, par of he higher dispersion may be explained by hese differen lenghs. Tesing his hypohesis by using four-week windows for all cenral banks shows ha he differences in he dispersion measures indeed become smaller and less significan. However, as his four-week period included wo policy meeings for he ECB prior o November 2001, such a es inroduces a bias in he resuls owards raising dispersion of ECB communicaion. 13

14 moneary policy inclinaion of Governing Council members are consisen wih he decision a he nex meeing, whereas only 56% of saemens of FOMC members shows such consisency. This difference proves saisically highly significan. The Bank of England akes an inermediae posiion wih 59%, which is no significanly differen from he shares of neiher he ECB nor he Federal Reserve. If he saemens were o signal fuure decisions, heir consisency should be higher han 50%. This is indeed he case for he ECB (a he 99% level) and he Bank of England (a he 95% level), bu no for he Federal Reserve. One reason for he relaively low degree of consisency of FOMC communicaion may lie in he fac ha he horizon of saemens may go beyond he nex meeing. In fac, much of he communicaion of he Federal Reserve in 2003 and 2004 has been sressing he medium-erm oulook for moneary policy. Panel B of Table 4 presens he consisency of communicaion wih he direcion of moneary policy. The resuls reveal ha indeed a much larger share of he communicaion for all cenral banks is consisen wih he direcion. For all hree cenral banks, our consisency measures are saisically differen from 50% a he 99% level. Neverheless, he consisency of saemens by Governing Council members is sill higher han ha for he Federal Reserve or he Bank of England, alhough his difference is no saisically significan any longer. Table 4 here In sum, we conclude ha communicaion exhibis significan differences in he degree of dispersion and of consisency across he hree cenral banks. Overall, for he Federal Reserve, communicaion appears o follow a more individualisic approach, aiming a providing he public wih he diversiy of views among FOMC members. By conras, communicaion sraegies follow a more collegiae approach, inending o mainly convey he commiee view and consensus among members for he MPC and in paricular for he Governing Council. 4.2 Communicaion on moneary policy meeing days An addiional elemen of communicaion sraegies is he saemens of he commiees as a whole, in paricular hose ha hey release on moneary policy meeing days. The hree cenral banks also differ in his regard. All hree release press saemens immediaely afer heir decisions. However, he press saemens are very disinc as he Federal Reserve provides a shor summary of he decision plus a balance-of-risks assessmen over he foreseeable fuure while he Bank of England only occasionally offers an addiional explanaion o is decision. None of he wo holds a press conference on he meeing day, and provide some addiional informaion a a laer sage hrough a quarerly Inflaion Repor and press conference, in case of he Bank of England, and a semi-annual repor o Congress, in case of he Federal Reserve. By conras, he ECB provides a press release as well as a press conference, including an exensive Q&A session, o explain is decisions. 14

15 In addiion o his official communicaion of he commiee as a whole, he minues of he FOMC and he MPC provide he voing behaviour of all individual commiee members. In conras, he ECB does no publish how a decision was made, alhough i has signalled frequenly ha here is a srong emphasis on consensual decisions, which ofen are achieved wihou conducing a formal voe. 10 An imporan elemen o analyse and assess he iner-meeing communicaions may be he quesion of how his decision is made, and in paricular how unanimous i is. The key poin is ha he effeciveness of he communicaion by individual members in he iner-meeing period is likely o be deermined in a cenral way by wheher or no his communicaion sraegy ranslaes ino a similar paern in he voing on moneary policy decisions. Looking a he voing paern in he cenral banks shows some sriking differences. For he FOMC, here were 7 ou of a oal of 44 meeings (or 15.9%) beween May 1999 and May 2004 in which he decision was no unanimous and in each bu one case here was only one dissening voe. 11 By conras, he MPC shows a remarkably high degree of dispersion in voing since independence in May In more han half of he MPC meeings, or 46 ou of 85 meeings (54.1%) did a leas one MPC member dissen wih he decision. The average number of disseners was abou wo ou of a maximum possible number of disseners of 4 in he nine-person MPC and in as many as 6 meeings was he decision made wih a majoriy of only a single voe i.e. 5 voes in favour versus 4 voes agains. On wo occasions, in February and March 1998, here was a ie as 4 members voed in favour of a ighening while 4 voed o keep raes unchanged. 12 Overall his shows a remarkable degree of dispersion for he MPC. 5. Effeciveness of communicaion We now urn o he quesion of wheher he described differences in communicaion sraegies across he hree cenral banks has led o differences in he effeciveness of communicaion as a ool of moneary policy. We define effeciveness as conaining wo elemens: firs, he abiliy of financial markes o predic fuure moneary policy decisions; and second, he abiliy of policymakers o influence financial markes by moving asse prices in he desired direcion. Clearly, hese wo elemens are no independen of each oher as communicaion ha leads o high predicabiliy of decisions should also have a significan effec on financial markes. Before conducing he analysis on effeciveness, we summarise he resuls so far and formulae he hypoheses concerning moneary policy effeciveness in he following way: 10 See, e.g., he answers of he ECB presiden o quesions on his issue a he press conferences of February 3, 2000, Sepember 12, 2002, or Ocober 10, Obviously, even in he case of unanimous decisions, some commiee members migh have expressed deviaing views before voing (Meade, 2004). 12 The voing records of he Bank of England and he Federal Reserve are in he public domain and are released wih he minues wo weeks and six weeks, respecively, afer each meeing. Noe ha he number of members in he MPC has been increased since independence and reached is curren size of nine members only in June

16 sraegy hypoheses: effeciveness communicaion communicaion voing predic- marke dispersion consisency wih dispersion abiliy responsiveness policy decisions Federal Reserve high medium low? high only o some members Bank of England low medium high medium medium uniform o all members European Cenral Bank low high none high high uniform o all members This able, in a nushell, summarises in a very sylised fashion he differen communicaion sraegies, based on our analysis above, by he hree cenral banks. The quesion is: wha do hese sraegies imply for he effeciveness of communicaion? In principle, one would expec ha more dispersion in communicaion and in voing, as well as lower consisency wih moneary policy decisions, should reduce predicabiliy and lower he responsiveness of markes o communicaion. However, markes may neverheless reac significanly o saemens by some individuals if hey expec ha his individual s view reflecs he majoriy view or a leas is powerful enough o sway he majoriy on his or her poin of view. Hence he communicaion sraegy of he Federal Reserve may indeed induce high predicabiliy and markes respond srongly, despie a high degree of communicaion dispersion, if markes are able o figure ou whose saemens o wach closely o. As commiee srucures generally give a srong weigh o he chairman, we will es wheher financial markes respond more srongly o his communicaion. As poined ou by Chappell e al. (2004), Chairman Greenspan generally speaks firs in he FOMC meeings and presens his policy proposal. For almos every meeing hey analyse, he majoriy of voers agreed wih he posiion he advocaed. For he Bank of England, he medium consisency wih decisions and he high voing dispersion may imply ha he iner-meeing saemens are no a very good indicaor for fuure decisions. Unless his is compensaed for by oher informaion, we would expec only a medium level of predicabiliy. I is furhermore no enirely clear wheher, in he occasions when he MPC conveys dispersed views in he iner-meeing period, financial markes should wach predominanly communicaion by he Bank of England s Governor. Alhough he Governor has a casing voe in he even of a ie, his role in he meeings of he MPC is very differen from Chairman Greenspan s in he FOMC (see he descripion of he MPC meeing srucure in Bean and Jenkinson, 2001): I is he Depuy Governor responsible for moneary policy who usually speaks firs, and is hen followed by he oher MPC members, who normally give an indicaion of heir policy preference. The Governor himself usually concludes he exchange of views, and, once all Commiee members have given heir views, [ ] pus a moion ha he expecs will command a majoriy and calls for a 16

17 voe (Bean and Jenkinson, 2001, p.438). Overall, herefore, we would expec a relaively weak effec of communicaion on financial markes for he Bank of England. By conras, for he ECB, communicaion in he iner-meeing period has low dispersion and he moneary policy decision is usually unanimous and consisen wih he decisions. One would herefore expec ha communicaion is highly effecive in allowing markes o correcly predic decisions. One would also expec ha financial markes reac o communicaion by all members as everyone s saemen should give an accurae indicaion of fuure decisions of he commiee. In his secion, we presen measures of predicabiliy o assess he firs elemen of effeciveness. We hen coninue by analysing in deail how differences in communicaion sraegies are explained and refleced in he diverse reacions of financial markes o he various ypes of communicaion. 5.1 Predicabiliy of moneary policy decisions If ransparency is presen and markes and policy makers have he same informaion, hen markes should also be able o anicipae moneary policy decisions reasonably well. This implies ha he unexpeced componen of he moneary policy decision, as proxied by changes in shor-erm ineres raes, should be small on meeing days. We es his hypohesis and he differences across he hree cenral banks, by analysing he size of he shor-erm ineres rae change on he day of he moneary policy decisions. We follow he approach of Perez-Quiros and Sicilia (2002) and use one-monh EONIA swap raes for he euro area, and one-monh LIBOR raes for he UK and he US. 13 Table 5 shows hese resuls for all policy meeings in panels A and C and only for hose meeings wih policy changes in panels B and D. Panels A and B exclude unscheduled meeings, whereas panels C and D include hem. A key resul is ha moneary policy surprises on all moneary policy meeing days are almos always saisically significanly higher for he Bank of England compared o he ECB and he Federal Reserve. For meeings including he unscheduled ones (panel C), he mean absolue surprise on he meeing day is 3.6 bp for he ECB, 5.6 bp for he Federal Reserve and 6.0 for he Bank of England. For hose days wih ineres rae changes (panels B and D), he mean absolue surprises of he hree auhoriies are very similar a around bp when including unscheduled meeings, and somewha lower for he Federal Reserve when excluding hem. 14 Table 5 here Overall, he key finding is ha he Federal Reserve and he ECB are roughly equally predicable in heir moneary policy decisions, where he concep of predicabiliy is based on he change of shor- 13 As explained in deail in Perez-Quiros and Sicilia (2002), one would ideally like o use overnigh raes, bu hese prove highly volaile due o oher facors, in paricular due o changes in liquidiy over he respecive mainenance periods. 17

18 erm ineres raes on he moneary policy meeing day. By conras, moneary policy decisions by he Bank of England are somewha less predicable. 15 The quesion ha arises from his resul is wha prepares markes in he Unied Saes and in he euro area so ha hey are beer able o anicipae policy decisions compared o he Unied Kingdom, and wha role communicaion plays in his conex. 5.2 Marke reacion o communicaion The second componen of effeciveness of communicaion is he quesion of wheher policy-makers are capable of influencing asse prices in he desired way. If communicaion is informaive abou fuure policy decisions, and hence moneary policy decisions are highly predicable, hen one would expec ha communicaion has a significan impac on asse prices. However, i should be sressed ha high predicabiliy does no necessarily imply ha i is communicaion which induces markes o correcly anicipae policy decisions. In fac, i has been argued by Bank of England Governor King (2000) ha, for a ransparen cenral bank, i should be he economic developmens ha allow policy decisions o be predicable, raher han communicaion by he auhoriy. 16 This subsecion ess for he impac of communicaion on financial markes. We look a boh he yield curve as well as a equiy prices, exchange raes and inflaion expecaions. Ineres rae daa are US Treasury bill raes for he US, and inerbank raes and governmen bond yields for he euro area and he UK. 17 Equiy reurns are he daily reurns of he major sock marke indices (he S&P500, FTSE100 and EUROSTOXX), and exchange raes (EUR/USD, UKP/USD) are closing quoes a EST. Inflaion expecaions are derived from inflaion-indexed five-year bonds. Communicaion may have a dual objecive from a financial marke perspecive: i aims a influencing he level of asse prices as well as he degree of volailiy and uncerainy. To allow esing boh as well as o accoun for he ineracion beween he wo, we model he effec of communicaion on asse price reurns r and on asse price volailiy h in a sandard exponenial GARCH (EGARCH) framework, proposed by Nelson (1991). Our EGARCH(1,1) model formulaes he condiional mean equaion for he asse price reurn r as a funcion of he iner-meeing communicaion (C EC, C MP ), he communicaion on meeing days (M EC, M MP ), pas reurns (r -i ), moneary policy shocks (s ) and a vecor of conrol variables (X): 14 The able also shows he variances of he absolue ineres rae surprises on he meeing days, and confirms ha his variance is lowes for he ECB and highes for he Federal Reserve, hough he differences are no always saisically significan. 15 A similar resul is obained in Moessner, Gravelle and Sinclair (2004) in a comparison of he Federal Reserve and he Bank of England. 16 King (2000) emphasises his poin as follows: A ransparen moneary policy reacion funcion means ha he news should be in he developmens of he economy no in he announcemens of decisions by he cenral bank. Hence a successful cenral bank should be boring raher like a referee whose success is judged by how lile his or her decisions inrude ino he game iself. 18

19 r = α + λ r + λ i EC i M EC i + β + λ MP EC C M EC MP + β MP + γ s C MP + δ X + ε (3) The vecor X of conrols includes day-of-he-week effecs and may also include various macroeconomic news variables o conrol for ensure ha our parameers of ineres, so ha β EC and β MP capure solely he effec of iner-meeing communicaion and λ EC and λ MP of communicaion of he commiees on meeing days. We have also esed wheher including he sock of communicaion affecs he reacion of financial markes o an addiional piece of communicaion. In his case, we included in he vecor of conrols also he variables = C i 1 i and = C i 1 10 EC 10 MP i, i.e. he sock of communicaion over he las 10 days. The resuls remain virually unchanged. For he UK, we canno disinguish beween he moneary policy and economic oulook componens in he communicaion on he meeing days (M EC, M MP ), as he minues are mosly backward-looking in explaining he decisions. However, as argued by Gerlach-Krisen (2004), he poenially mos imporan aspec o gauge an inclinaion of he MPC from he minues is he voing record. Following Gerlach-Krisen, we herefore include in he mean equaion (2) he average voing dissen from he MPC decision, and a dummy in he volailiy equaion (4) for hose days when he MPC minues are released. 18 In order o idenify he effecs of communicaion on meeing days, i is crucial o conrol for he effecs of moneary policy shocks s on his day. Our measure of shocks is based on he change in shor-erm raes as explained in secion 5.1. We assume ha ε = h v, wih v is an i.i.d. sequence wih zero mean and uni variance. The condiional variance h can herefore be expressed as a funcion of communicaion dummies (CD EC, CD MP, MD EC, MD MP ), he pas variance (h -1 ) and innovaions ( ε 1 ), and he conrols X : ln ( h ) ω θ 1 θ θ ( h ) + κ EC = CD EC ε 2 ε 1 ln h π h κ MP CD MP + ρ EC MD EC + ρ MP MD MP + ϕx (4) The EGARCH approach correcs for he kurosis, skewness, and ime-varying volailiy of he asse price. An addiional advanage of he EGARCH approach is ha we do no need o impose non- 17 All resuls for he UK are robus o using he more liquid wo fron shor serling conracs raded on LIFFE. To mainain comparabiliy across counries, we repor resuls for LIBOR raes in his paper. 18 We also experimened wih including a dummy for he releases of FOMC minues, bu i proved o have no significan effec on financial markes. This finding is sensible as FOMC voing is mosly unanimous, as discussed above, and also as he relevan informaion abou he FOMC s inclinaion is released wih he balance-of-risks assessmen on he FOMC meeing days, and no wih he minues. 19

20 negaiviy consrains on he condiional second momens. The model is esimaed via loglikelihood esimaion of he funcion T L( µ ) = ln(2π ) T = 1 2 ε ln( h ) + h wih µ he vecor of parameers of ineres and T he number of observaions. (3)-(4) consiues he benchmark model underlying our analysis of effeciveness. Table 6 shows he resuls for he condiional mean equaion (3) and Table 7 for he condiional variance equaion (4). The overall resuls are compelling. Moneary policy communicaion generally has a significan effec on he shor and medium-erm horizons of he yield curve. For Federal Reserve saemens he effec is around 1 o 1.5 basis poins on average, and is found consisenly for all mauriies beween hree monhs and 5 years. For he Bank of England, where we would have expeced less of a reacion of financial markes, we do indeed find much smaller coefficiens below one basis poin. Finally, for he ECB, where our hypohesis was ha markes would generally reac o communicaion, as i serves as a useful indicaor for fuure moneary policy decisions, we find a highly sysemaic paern like for he Federal Reserve, in ha all mauriies up o 5 years are affeced significanly, and he effecs are he larges of all hree cenral banks, ranging from 1.7 o 2.8 basis poins. Tables 6 and 7 here The second se of resuls refers o he marke response o saemens abou he economic oulook. The sriking finding of Table 6 is ha mainly US markes reac o such saemens by he Federal Reserve, and he effecs are sronges a he medium o long end of he yield curve. By conras, markes do no reac, or much less so, in he UK and he euro area o such communicaion. One inerpreaion is ha hese responses reflec he differen moneary policy reacion funcions of he hree cenral banks. The sraegies of he Bank of England and he ECB focus on price sabiliy whereas he Federal Reserve gives a sronger weigh o he real economy, and he findings of Table 6 mirror he marke percepion and anicipaion of hese sraegies. Third, communicaion also has a significan effec on oher asse prices. A saemen indicaing a bias owards ighening leads o a drop in equiy markes in he US and he euro area and an appreciaion of he exchange rae in he euro area. Inflaion expecaions are basically unaffeced by communicaion. Moreover, he response of volailiy o moneary policy communicaion is ofen posiive, in paricular in he US (Table 7). In order o undersand wheher he effecs of communicaion on financial markes are also economically imporan, we have compared he magniude of he coefficiens in able 6 wih he 20

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