Policy Words and Policy Deeds: The ECB and the Euro*

Transcription

1 Policy Words and Policy Deeds: The ECB and he Euro* Pierre L. Siklos Deparmen of Economics and Viessmann Research Cenre on Modern Europe Wilfrid Laurier Universiy Waerloo, ON Canada N2L 3C5 Marin T. Bohl Deparmen of Economics Wesfälische Wilhelms Universiy Münser Münser, Germany * Porions of his paper were wrien while boh auhors were visiing researchers a he Bank of Finland. Commens by seminar paricipans a he Bank of Finland, he Hong Kong Moneary Auhoriy, and he Cenral European Universiy, are graefully acknowledged. A previous version was also presened a he workshop on ECB Communicaion, held a he Swiss Insiue for Business Cycle Research, Zürich. Boh auhors are also graeful o he Alexander von Humbold Foundaion for financial suppor. Helinä Laakkonen, Emmi Marikainen, Heli Tikkunen, Sergeiy Ragulin, and Garry Tang provided excellen research assisance. A separae appendix conaining resuls no presened in he paper is available from he firs auhor on reques.

2 Policy Words and Policy Deeds: The ECB and he Euro Absrac: This paper examines he role of he ECB communicaion aciviies on daily Eurodollar exchange rae and ineres raes. We esimae he relaionship beween moneary policy and he exchange rae using a echnique ha explicily recognizes he join deerminaion of boh he levels and volailiies of hese variables. We also consider more radiional esimaion sraegies as a es of he robusness of our main resuls. We inroduce a new indicaor of ECB communicaions policies ha focuses on wha he ECB says abou he fuure economic oulook for he euro area along five differen economic dimensions. The impac of ECB communicaions policies is more apparen in he ime series framework han in he heeroskedasiciy esimaor approach. Time series esimaes reveal ha ineres rae changes generally have a much larger impac on exchange rae movemens, and heir volailiy, han do ECB verbal pronouncemens. Previous sudies ha conclude ha news effecs are significan a he daily frequency may have reached such a conclusion because he measuremen of news was oo highly aggregaed. The endogeneiy of he exchange rae-ineres rae relaionship is more apparen when he proxy for moneary policy is he euro area-us differenial han when any oher proxy for moneary policy is employed. JEL Classificaion Codes: F3, E5, E6 Keywords: Cenral bank communicaion, Eurodollar exchange rae, 1

3 1. Inroducion The brief hisory of he euro o dae is a urbulen one. Some have poined o he fac ha a new and unried moneary insiuion became responsible for a single moneary policy in 11 sovereign saes as one reason for he urbulences. Ohers have focused on he inabiliy of he fledgling cenral bank o clearly communicae is policy sance. Criics of he European Cenral Bank (ECB) like, for example, Svensson (2003) argue ha is wo-pillars policy is confusing, if no downrigh inappropriae. 1 Ohers have praised he ECB, especially under is firs Presiden, Wim Duisenberg, for rying o avoid a all coss he empaion o surprise markes (Sims 2004). Evidence, boh of he ime series and even sudy varieies, poins o some significan impac of ECB deeds and words on he Eurodollar exchange rae and a modes, bu improving, credibiliy (e.g., Faum and Huchison 2002, Jansen and De Haan 2005, Frazscher 2004, Goldberg and Klein 2005) which suggess some capaciy on he ECB s par o surprise markes. On a number of occasions he imporance aached by senior ECB officials o he euro exchange rae, and is volailiy, has been unclear. For example, Duisenberg was quoed as arguing ha, while he Eurodollar exchange rae is an imporan indicaor, here is lile reason o influence is value as a maer of policy. Neverheless, he former ECB Presiden, who lef office in November 2003, expressed a concern abou he volailiy of he Eurodollar exchange rae (Duisenberg 1999b). His successor, Jean-Claude Triche, 1 The ECB, on is own accoun, conduced a review of is moneary policy sraegy in The wo-pillars approach consiss in combining a price sabiliy objecive aiming for below bu close o 2% inflaion, ogeher wih a reliance on moneary indicaors o help ensure ha he price sabiliy objecive is being me over he medium-erm. 1

4 apparenly feels he same way, a leas if we inerpre a commenary of his wrien for he French press (Triche 2005). 2 The boom line is ha he ECB, as do oher cenral banks, use a mix of words and deeds o influence expecaions. I is less clear wheher he saemens of cenral bankers can influence exchange rae levels or is volailiy. Indeed, Bini Smaghi (2006) warned financial markes ha he clariy of signals abou fuure ineres rae movemens will depend on he circumsances, and ha precise guidance canno always be forhcoming from cenral banks. Since ineres rae decisions have implicaions for exchange rae dynamics here is even more reason o explore he impac of words versus deeds on he euro exchange rae. This paper examines how policy acions, namely ineres rae decisions, words, or open mouh operaions, of he ECB, and marke news combine o impac changes and he volailiy of he euro/usd exchange rae. To do so, he researcher faces a well-known idenificaion problem. An example illusraes his phenomenon. In Sepember 2000, he ECB formally inervened in foreign exchange markes in suppor of he Euro. In Sepember 2001, he US experienced erroris aacks wih worldwide repercussions for financial markes. Boh evens, one policy relaed he oher no, had a emporary effec on he levels of he Eurodollar exchange rae. In conras, only he policy inervenion by he ECB appears o have had a noiceable impac on exchange rae volailiy. This suggess ha one useful way of idenifying he impac of cenral bank acions, boh verbal and direc varieies, is o uilize he informaion conained in he volailiy of exchange rae 2 Similar concerns are also being voiced in he US where minues of he FOMC in November 2005 sugges ha he Fed may provide markes wih less guidance in fuure ( 2

5 movemens. Indeed, his is he device used in his paper o deal wih he endogenous relaionship beween ineres raes and exchange raes. While no he only device available under he circumsances, his approach sheds new ligh on he deerminans of he euro/usd exchange rae a he daily frequency. Our sudy adds o a small bu expanding lieraure ha aemps o idenify how he acions and saemens made by ECB officials influence he exchange rae. Sudies ha consider how news or cenral bank pronouncemens affec asse prices ypically rely on a raher narrow se of variables o capure surprise announcemens. The universe of poenial informaion ha can have an impac on he exchange rae is undoubedly large. Consequenly, we rely on a principal componens analysis o reduce he dimensionaliy of poenial sources of news effecs on he Eurodollar exchange rae. 3 This sraegy proves o have imporan implicaions for he significance of news evens on exchange rae developmens even a he daily frequency. The res of he paper is srucured as follows. The following secion reviews he relevan lieraure on news effecs and moneary policy wih paricular reference o he relaionship beween asse prices and cenral bank behavior. Nex, we describe he daa used in he sudy prior o presening some sylized facs abou he daa se in quesion. 3 Dominguez and Panhaki (2006) widen he vecor of variables ha radiionally consiue news for foreign exchange markes o include informaion no ypically considered fundamenal in an economic sense. They conclude ha he explanaory power of high frequency models of exchange rae behavior can be subsanially improved wih he addiion of such variables. 3

6 The empirical evidence is hen discussed afer a discussion of mehodological issues. The paper concludes wih a summary and quesions lef for fuure research. 2. News and he Exchange Rae: A Selecive Lieraure Review The lieraure on news and is impac on various financial asse prices, including he exchange rae, is exensive. In he pas, research has ended o concenrae on he impac of news releases originaing primarily from he financial press on ineres raes, exchange raes and sock reurns issued (e.g., Cochrane 2005, Campbell, Lo, and MacKinlay 1997). In general, here is growing ineres in aemping o exrac a separae influence from various ypes of news releases emanaing from cenral banks (e.g., Gürkaynak, Sack and Swanson 2005, Siklos and Bohl 2006). 4 Recenly, aenion has urned o he reacion of ineres raes and exchange raes o news. Ehrmann and Frazscher (2004a), Frazscher (2004), Jansen and De Haan (2005), Goldberg and Klein (2004), and Beine, Janssen and Lecour (2004) represen jus a sampling of recen empirical sudies of he impac of news on exchange rae movemens and heir volailiy. A few sudies (e.g., Connolly and Kohler 2004, Rigobon and Sack 2004) use ineres rae fuures or forward exchange raes o proxy forward-looking senimen in financial markes. There are also sudies ha examine changes in (spo) exchange raes and heir reacion o news, as repored by he financial press, cenral banks, or boh (e.g., Ehrmann and Frazscher 2003).There are a leas hree explanaions for his developmen. Firs, many cenral banks now rely on an overnigh ineres rae, or a similar insrumen, 4 For a survey of he kinds of informaion now provided by cenral banks on a regular basis, see Siklos (2002). 4

7 o guide he general level of ineres raes. Second, moneary auhoriies in a large number of counries are now seen as more auonomous, ransparen, and accounable o governmens, in paricular, bu o markes and he public more generally (e.g., Bernanke, Laubach, Mishkin, and Posen 1999, and Siklos 2002). In response, cenral banks have become more alkaive. There is growing recogniion ha moneary auhoriies can influence markes on a daily basis. Finally, here is a possibiliy ha, a imes, he words of cenral bankers migh subsiue for direc acion (Siklos and Bohl 2006, Gürkaynak, Sack, and Swanson 2005). In wha follows we briefly focus on hree quesions ha have pre-occupied researchers in recen years. They are, no necessarily in order of imporance: he esimaion mehodology employed, he measuremen of news effecs, and he choice of sampling frequency. Esimaion ofen proceeds by regressing he change, or expeced change, in he financial asse price of ineres on proxies for unexpeced evens since his is wha is believed o consiue news. The relevan proxies are hemselves generaed in a variey of ways, as will be explained below. However, mos objecive measures of news or surprises are defined in he following fashion: s k, Ak, Ek, =, (1) σ k, where s, is he surprise componen of an announcemen ype k, a ime, which is k evaluaed as he difference beween he announced value of he economic indicaor in quesion A and is median or mean expeced value E based on forecas or survey daa. Dividing by he sample sandard deviaion σ of announcemens of he same variey 5

8 sandardizes A k Ek,,, and permis a comparison of regression coefficiens across differen kinds of announcemens. Mos of he esimaed models end o be univariae regressions, possibly wih oher added conrols. Since Engle s (1982) seminal work, i is now cusomary o argue ha unexpeced evens can simulaneously influence he volailiy of asse prices, and no jus heir levels. This has led mos researchers o resor o condiional volailiy models, usually of he GARCH(1,1) or EGARCH(1,1) variey, since hey are ofen successful specificaions aimed a capuring he ime-varying naure of volailiy in asse reurns. Almos all of he papers cied earlier can be characerized as adoping eiher one or boh esimaion sraegies in quesion. A few sudies have also recognized ha asse markes for differen financial asses are linked and, a leas in par, possibly joinly deermined and have proposed an alernaive esimaion sraegy o deal wih he endogeneiy problem (e.g., Rigobon and Sack 2004, Bohl, Siklos, and Werner 2006). Thus, for example, a connecion beween sock reurns and bond yields has long been hough o exis. 5 Similarly, here is he wellknown uncovered ineres pariy relaionship beween exchange raes and ineres raes differenials, or he link beween he slope of he yield curve and economic fundamenals. Each of hese approaches has generaed a voluminous lieraure. All of hese sudies share a common feaure, namely reliance on ime series modeling. In conras, he finance lieraure has ofen relied on even ype sudies wherein 5 The relevan lieraure has a long hisory, hough he evidence soring ou he mos empirically relevan links is unclear, as several hypoheses exis relaing sock marke behavior o ineres rae movemens. For example, see Canova and De Nicolo (2000). 6

9 he reacion of a financial asse price is measured wihin a somewha arbirarily defined window of ime. While such sudies can be useful, hey do suffer from he fac ha, however narrow he window, oher facors ha can influence he link beween news and asse price reurns are no necessarily adequaely conrolled for. 6 We reurn o his issue below. Clearly, he poenial role of news will crucially depend on he variables used o measure i. A he risk of oversimplifying maers, here are wo ypes of variables ha are hough o represen news. Governmens, and oher privae insiuions, release a heavy flow of daa a regular inervals. Ofen, such announcemens arrive during he firs wo weeks of each monh. Some are iniial esimaes of curren economic condiions ohers are revised figures from earlier daa releases. Almos simulaneously, boh curren forecass and ones over some specified fuure horizon, are also released. Hence, he difference beween a curren release and he relevan forecas, serves as a proxy for a surprise announcemen. For he US alone, he Bloomberg service repors a leas 83 announcemens on a regular basis, usually monhly or, occasionally, quarerly. Some auhors (e.g., Andersen, Bollerslev, Diebold, and Vega 2005) differeniae beween posiive, or favorable, and negaive, or unfavorable, news evens. However, here are no sysemaic aemps o explain how he selecion of news releases for analysis is chosen. For example, Ramchander, Simpson, and Chaudhry (2005) rely on 23 separae releases of US macroeconomic indicaors, in a sudy of news effecs on bond yields, while Connolly and Kohler (2004) use only 12 announcemen ypes from he same source. This implies ha mos sudies of news effecs ha rely on 6 MacKinlay (1997) reviews he even-sudy lieraure. Also, see LeRoy (2004). 7

10 announcemen ype daa resor o a form of censoring. Alhough he degree of censoring is an empirical quesion, here is lile doub ha some announcemens may, or may no, consisenly affec asse markes, and he exchange rae in paricular, even if he announcemen in quesion is deemed o be one ha markes are believed o reac o on a regular basis. More recenly, and in line wih he burgeoning ineres in he impac of cenral bank policies on asse price developmens, several auhors have sough o quanify, ypically via he specificaion of dummy variables, he significance or meaning of saemens, press releases, speeches, and oher announcemens emanaing from cenral bank officials. In some cases (e.g., he US Fed, he ECB, and he Bank of England) he mere fac ha officials who se he course of moneary policy mee a regular, pre-announced, inervals gives rise o he possibiliy of news around meeing days. Ehrmann and Frazscher (2004b), Frazscher (2004), Jansen and De Haan (2005), Kohn and Sack (2003), and Beine, Janssen and Lecour (2004) are sudies ha aemp o classify words and deeds of cenral bankers alongside oher sources of news. While many of he news sources are of he objecive variey, ha is, hey are quanifiable, ohers are subjec o he inerpreaion of he researcher who is aemping o deermine from a paricular saemen, or speech, wheher a cenral bank official is calling for higher or lower fuure ineres raes, or some oher financial asse price such as he exchange rae or sock prices. Consequenly, as noed previously, here is clearly poenial eiher for bias or for inerpreing saemens differenly in hindsigh. I is also conceivable ha saemens are deliberaely mean o obscure a cenral bank s likely course of acion. 8

11 Neverheless, o he exen ha he cenral bank is reasonably ransparen abou wha i deems o be he fuure oulook for he economy, such saemens, ogeher wih he publicaion of inflaion repors and saff forecass, can be reasonably said o conain some informaion abou likely cenral bank acions. 7 Jus as imporan, here is a conscious aemp o idenify saemens ha signal igher versus looser fuure moneary policy or a sronger or weaker fuure value for he exchange rae (e.g., Frazscher 2004, Faum and Huchison 2002). Hence, asymmeries in he conduc of moneary policy are explicily recognized. Anoher form of asymmery comes from he geographic source of news evens. For mos counries, news from US sources would have a significan independen influence on oher counries financial markes (e.g., Connolly and Kohler 2004). Regardless of how qualiaive saemens are measured, hey are ypically assumed o have, a mos, a emporary same day effec on he asse reurn in quesion, in keeping wih he noion ha news effecs dissipae quickly. The foregoing brings us o he quesion of sampling frequency. Goodhar e al. (1993), and Andersen e al. (2005), among ohers, find ha news evens dissipae wihin a maer of hours. Hence, esimaing news effecs on asse prices a, say, he daily frequency will generally under esimae he shor-run effec of unexpeced evens on asse prices. The recen evidence of Gürkaynak, Sack, and Swanson (2005) would appear o suppor such a view. Dominguez and Pahanak (2005) also consider inra-daily news 7 Depending upon wheher marke paricipans read complee saemens from cenral bank officials, insead of a selecion published in, say, a paricular newspaper source, his will have consequences for he possibiliy of media spin or bias (Mullainahan and Shleifer 2004). 9

12 effecs bu conclude ha previous sudies define news raher narrowly. As a resul, hey are able o conclude ha here is useful informaion conen a he daily frequency. Ehrmann and Frazscher (2004a,b) also defend he resor o daily daa on he grounds ha inra-daily daa capure an overreacion o news evens 8 which does no enirely eliminae he possibiliy ha news effecs are longer lived han some believe. Ohers believe ha invesors underreac o informaion, especially of he bad variey. Moreover, here is a presumpion ha markes reac o he same news a he same ime. No only is news ransmied o differen markes wih a delay, albei a shor one, here is considerable evidence ha agens censor informaion. In addiion, cenral banks communicae no only o financial markes bu o he public more generally. If using ulra-high frequency daa, should we rely on he exac iming of he release of informaion o newswire, or raher rely on he iming of when he informaion (e.g., as in a speech) is acually released? Also, once inra-daily daa are used, he invesigaor mus choose a window (e.g., 5 minues or 20 minues) and here is he possibiliy ha such a choice can bias findings abou he srengh of he connecion beween news and exchange rae behavior. Lasly, he focus on exchange rae developmens ignores he informaion conen in he volume of ransacions. Andersen and Bollerslev (1998) documen he poenially imporan role of he volume of ransacions in explaining he volailiy of exchange rae movemens, while Evans and Lyons (2003, 2005) argue ha here is informaion conen 8 This is a reflecion of he so-called irraional exuberance phenomenon coined by Alan Greenspan, and laer emphasized by Shiller (2000). 10

13 on he order flow in currency markes. The role played by he order flow seems o be poenially more imporan for inra-daily daa han a he daily frequency Esimaion Sraegy and Economeric Issues Exchange raes and ineres raes are joinly deermined. Define rae of change in he nominal Euro-US-dollar exchange rae, Δ e o represen he MP is an indicaor of moneary policy, such as an ineres rae or an ineres rae differenial, and C summarizes he informaion conen of press releases and oher forms of communicaions emanaing from he ECB. We can wrie he relaionship of ineres as follows: MP = β Δe + δc + γz + ε, (2) where Δ e = α MP + θc + Z + η, (3) Z represens a vecor of oher variables (normalized o one in equaion (3)) ha influence moneary policy and he exchange rae such as news announcemens, day of he week effecs, and so on, assumed o be exogenous. All oher variables were previously defined. Equaion (2) is a policy reacion funcion, while equaion (3) conains he parameers of ineres, namely α and θ. The parameer α measures he impac of moneary policy on he exchange rae and θ capures he effec of ECB communicaions on he Euro-US-dollar exchange rae. The errors ε and η are, respecively, he shocks 9 They also allude o a possible addiional advanage of relying on daily daa, namely ha his is he highes frequency a which he exchange rae can be described as a maringale. By conras, exchange raes end o be mean revering a ulra-high frequencies. 11

14 o moneary policy and he Euro-US-dollar exchange rae. The disurbances are assumed o be serially uncorrelaed, E( ε, η ) = 0 and E( ε, Z ) E( η, Z ) = 0. = As in Rigobon and Sack (2004), equaions (2) and (3) impose a minimum of srucure on he daa. However, hese same equaions canno be consisenly esimaed using OLS because of he simulaneiy issue discussed earlier. Insead, Rigobon and Sack (2004) recommend idenifying wo sub-samples, such ha: P NP ε σ ε σ > (4) P NP η σ η σ = (5) P Z NP Z σ = σ (6) P NP where σ and σ refer o he volailiy of he ime series of ineres in policy (P) and non-policy (NP) samples. These sub-samples are defined below in greaer deail. Expressions (4) o (6) represen idenificaion assumpions where i is hypohesized ha policy shocks are greaer on policy days han on non-policy days (inequaliy (4)). The combinaion of ineres rae announcemens and economic oulook informaion conained in press releases explain such an inequaliy. Inequaliies (5) and (6) assume ha shocks o asse prices and o oher exogenous influences on Δ e and MP are he same on policy and non-policy days. As argued in Rigobon and Sack (2004), inequaliies (4) o (6) represen a weaker se of inequaliies han in he radiional even-sudy approach where i is assumed ha he variabiliy of policy shocks is sricly greaer han he variance of eiher exogenous influences on σ η ). MP and Δ e or hose in he exchange rae equaion (i.e., 12

15 Rigobon and Sack (2004) discuss how α and θ can be esimaed by implemening insrumenal variable esimaion. Define he following variables o include a proxy for moneary policy and he exchange rae on policy and non-policy daes such ha all days in he sample may be included: MP { MP P} { MP NP} =,,, (7) { Δe P} { Δe NP} Δ e =,,, (8) which are boh 2T x 1 vecors (where T is he number of policy daes). Now define he following insrumens: w w MP e { MP P} { MP NP},,, (9) { Δe P} { Δe NP} =,,, (10) Rigobon and Sack s (2004) approach implies ha esimaes for α can be obained by regressing he change in he in he exchange rae, Δ e, on he MP proxy (or is change) over he combined P and NP samples, using insrumenal variables esimaion where w MP and w e are he insrumens. They furher demonsrae ha w MP and w e are valid insrumens for esimaing α under he assumpions ha he parameers in (1) and (2) are sable, ha asse price shocks are homoskedasic, and ha moneary policy shocks are heeroskedascic. 10 The framework also permis esing wheher he relaively more sringen assumpions of he radiional even sudy approach can be rejeced. As 10 The ses P and NP are assumed o have he same number of observaions. If he number of observaions in hese ses differs, Rigobon and Sack (2004) argue ha he insrumens and he variables have o be divided by he square roo of he number of daes. 13

16 demonsraed by Rigobon and Sack (2004), a Hausman ype specificaion es is used o es he null ha he even sudy assumpions hold. Finally, i is worh comparing he resuls from he foregoing idenificaion approach agains esimaes from radiional ime series esimaion. This would consis in a condiional volailiy model, ha is, joinly esimaing equaion (3), he focus of our invesigaion, and he condiional variances via an EGARCH(1,1) model which is wrien: = ln( h ) τ 0 + τ1( ξ 1 / h 1) + λ ξ 1 / h 1 + α' MP + θ ' C + τ 2 ln( h 1), (11) where h is he condiional variance and all oher erms have already been defined. The EGARCH(1,1) formulaion has a number of advanages over he popular GARCH(1,1) alernaive, including he fac ha h can never be negaive, he sandardizing of ξ as well as he possibiliy of esing for asymmery depending on wheher τ 1 is posiive or negaive. Many in he relaed lieraure have resored o he EGARCH for he same reasons enumeraed above. Equaion (2) would similarly have an EGARCH(1,1) represenaion Daa To ensure comparabiliy wih much of he recen lieraure on he deerminans of eurozone exchange raes and he communicaions aciviies of he ECB, we rely on daily 11 In principle, esimaes of α ' and θ ' could hen be similarly idenified using he Rigobon-Sack procedure oulined above. While we have done so (resuls no shown) he relevan economeric heory has no ye been developed for his case. 14

17 daa since Exchange rae, ineres rae, and oher financial asse prices are from Daasream, Reuers, and Bloomberg. Daa for he euro reference exchange rae vis-á-vis he US dollar are from he ECB. Ineres rae daa for he euro area consis of yields on repos (eurepo) and he euribor for various mauriies. 12 For he US, he fed funds, fed funds arge and fed funds fuures daa were obained from Daasream, as were forward exchange raes for he euro agains he US dollar. Fed fund fuures daa are for overnigh fed funds held for 30 days published by he Chicago Board of Trade. Insiuional daa, consising of saemens from cenral bankers, he daes of meeings of he Federal Open Marke Commiee, and he ECB s governing council, are from he web sies of he US Board of he Governors of he Federal Reserve Sysem ( and he ECB ( Resuls from he Reuers Poll of ECB ineres rae expecaions were obained from Reuers. Also from Reuers are he implied volailiies for a he money foreign currency opions for a variey of mauriies ranging from one week o one year. Alhough he jury is ou on wheher implied volailiies provide relaively superior forecass of fuure volailiy, financial marke paricipans find hem o be a useful way of gauging large price changes primarily because of liquidiy concerns. Hence, implied volailiies may be especially useful in capuring informaion abou high sress evens. Forecass for inflaion and real GDP growh for he US, he euro area, and individual euro area counries are from Consensus Economics ( Consensus economics surveys paneliss during he firs wo weeks of 12 The euribor (euro inerbank offer rae) and EONIA (euro overnigh index average yield) are he benchmark money marke insrumens for he euro area ( 15

18 each monh when here is generally a heavy flow of daa announcemens which are mos likely o lead o revisions of forecas. Daa for macroeconomic announcemens, consising of an expecaion based on a survey of economiss, ogeher wih acual, prior values for he indicaor in quesion, as well as revisions o previous daa releases, were obained from Bloomberg. The figures ha are repored are averages. We now urn o a descripion of he announcemens daa, usually he workhorse variable for measuring surprises in high frequency daa. Daa were obained from Laakkonen (2004) and updaed from sources lised in her sudy. We include announcemens from he US, he U.K., Japan, he European Union (or euro area), and Germany. The oal number of available announcemens is 83 for he US, 82 for he U.K., 92 for Japan, 75 for he EU, and 101 for Germany. Because of changes in he daa, or he absence of a survey componen prevening he calculaion of a surprise componen, he fracion of he universe of available announcemens acually used was as follows: 34% for he US, 22% for he U.K., 20% for Japan, 17% for he EU, and 13% for Germany. Consequenly, a oal of 91 announcemens are used, a number far higher han in comparable sudies of his kind. Business cycle informaion for he US is obained from he NBER ( while, for he euro area, hese daa are available from he euro area business cycle nework ( Lasly, we searched Faciva ( a news rerieval service for news repors ha cied ECB and moneary policy, ineres rae, or exchange rae in he headline and lead paragraph and couned he references. This coun daa is a useful companion o he announcemens 16

19 daa as i can be informaive abou he inensiy wih which news repors draw aenion o cenral bank acions and words. 13 This paper also inroduces new ime series ha quanify saemens issued by he ECB and Federal Reserve, based on informaion conained in press releases, alhough oher cenral bank publicaions were also consuled (e.g., moneary policy, inflaion repors, minues of meeings, if available). Each press release is daed and inerpreed for conex as well for wheher i conains saemens ha reflec posiively or negaively on he economic oulook along five dimensions. They are: he exchange rae, oupu, asse prices, fiscal policy, and inernaional developmens or consideraions. A posiive oulook signifies ha higher real GDP growh, lower inflaion are forecas, an appreciaing currency, or ha financial asse prices more generally are considered o be a fundamenally sound levels. Dummy variables were hen creaed for each of he media releases aking on a value of +1 in he case of a favorable developmen, a -1 in he even of a negaive developmen, and zero oherwise for each of he six caegories previously menioned. When a press release menioned more han one of he aforemenioned caegories all such references were recorded. Consider he following example: In addiion, any 13 The coun daa exclude republished news, recurring pricing and marke daa, obiuaries, spors, and calendars. In spiri a leas, our coun daa is similar o he keyword coun variable creaed by Cecchei (2003) o proxy he concerns of he US Fed abou sock marke developmens and he possibiliy of a bubble. While coun daa is a useful indicaor, hey do no discriminae beween news iems ha look back versus news ha relaes o he economic oulook for he variables of ineres. 17

20 relaxaion of fiscal policies would negaively affec he price climae as well as he credibiliy of he Sabiliy and Growh Pac (ECB, 7 January 1999). This was inerpreed as implying a negaive oulook for fuure inflaion. he euro area has appreciaed agains he currencies of he euro area mos imporan rading parners. The Governing Council considers he developmen o be a sep in he righ direcion (ECB, 14 December 2000). This saemen suggess a posiive oulook for he exchange rae. This pracice was also followed for Federal Open Marke Commiee saemens. There are oher inerpreaions of cenral bank press releases in he lieraure, such as he oral inervenions variables consruced by Frazscher (2004). In conras, Frazscher s (2004) scale focuses exclusively on he connecion beween moneary policy and exchange rae developmens. A +1 is assigned o a saemen advocaing an appreciaion of he euro, a -1 for a depreciaion, and a zero when he saemen is ambiguous. One difference beween Frazscher s indicaor and ours is ha we were more ineresed in isolaing saemens abou fuure oulook for he economy. Afer all, i is unlikely, a priori, ha saemens abou he exchange rae can be divorced from oher relaed economic indicaors such as ineres raes and inflaion. Moreover, our classificaion parses saemens ino several differen caegories. As a resul, none of he saemens were fel o be ambiguous abou some indicaor of economic aciviy. I needs be emphasized ha our coding of he words of cenral bankers is no unique. For example, Jansen and de Haan (2005) code saemens by all cenral bankers in he euro area, and no only ones emanaing from he ECB. However, only he commens dealing wih he euro are classified. Similarly, Rosa and Verga (2005) focus on he conens of ECB press release alone in order o derive a measure ha represens 18

21 he likelihood of an official ineres rae change, and he resuling ordered scale ha ranslaes he same ypes of ECB documens considered here ino risk for price sabiliy and economic growh caegories. 5. Sylized Facs Alhough he ECB communicaes frequenly, i is more likely o do so around he ime of he meeings of is Governing Council. To he exen ha is meeings, and subsequen press conference, 14 influence financial markes his ough o affec he volailiy of moneary policy and exchange rae shocks. As noed previously, he sory of he Euro-US-dollar exchange rae canno be divorced from moneary policy in he US Figure 1 plos he ECB main refinancing operaions rae and is proximae US equivalen, namely he fed funds rae for he sample covered in his sudy. For roughly he firs half of he sample he US policy rae was higher han he comparable rae for he euro area. Afer 2001 he siuaion is reversed. By he end of 2004 he fed funds rae began o edge up over he ECB reference rae. Hence, he sample covers a long enough sample wherein he moneary policy sances and economic oulook of he wo cenral banks appear o have changed subsanially over ime. Figure 1 abou here 14 The Governing Council usually mees wice a monh. A is firs monhly meeing, he policy rae is se while he second meeing is held o discuss oher aspecs of ECB policy making. The able o be discussed below assumes ha volailiy is poenially affeced by he firs meeing dae. We reurn o his issue below. 19

22 Figure 2A plos he sandard deviaion for seleced ime series around specific even days. They are he rae of change in he Euro-US-dollar exchange rae, he change in he EONIA, he differenial beween he EONIA and he fed funds rae, and he change in he implied volailiies for one week opions. The evens chosen are days when he ECB s Governing Council mees bu does no se he policy rae, he day before he Governing Council mees, days when he ECB Presiden esifies a he European Parliamen, and days when he so-called EMU poll of ineres rae forecass is released. For mos proxies here are considerable differences in he volailiy of he underlying ime series bu his is only suggesive of he role of ECB words and deeds as hese even days also overlap wih oher news releases. For example, he implied volailiies are subsanially more volaile on days when he ECB Presiden esifies before he European Parliamen. Similarly, he EONIA-fed funds rae differenial is mos volaile around he ime of he release of he EMU poll of ECB ineres raes. Neverheless, uncondiional volailiies give only a parial picure of wha drives changing volailiies. Figure 2 abou here Turning o he US evidence, as illusraed by Figure 2B, evens in he US on days when he FOMC mees versus he preceding days also show a modes impac on he Euro-US-dollar exchange rae volailiy, wih more noiceable effecs on implied volailiies and he EONIA/fed funds ineres rae differenial. Also shown is he relaively higher volailiy of fed funds fuures repored by several oher researchers This resul may simply indicae ha FOMC meeing days are more newsworhy han non-meeing days. Poole and Rasche (2000), Poole, Rasche and Thornon (2002) and Kuner (2001), find ha he Fed had become more ransparen over ime. Indeed, 20

23 Figure 3 shows changes in he euro area-us ineres rae differenial agains he rae of change in he Euro-US-dollar exchange rae. Presumably, on non-policy days, fundamenals and non moneary policy relaed shocks dominae whereas, on days when he Governing Council mees, i is he ECB s reacion funcion ha predominaes. As seen in he op porion of Figure 3, he bulk of he scaer suggess no obvious connecion beween changes in he ineres rae differenial and he rae of appreciaion or depreciaion in he exchange rae on non-policy days. Turning o he same relaionship on days when he ECB ses is policy rae, here are sronger indicaions ha changes in he ineres rae differenial are negaively relaed o changes in he exchange rae. 16 Choosing oher pairs of variables does no fundamenally change he sory. Figure 3 abou here On announcemen days news is given by k s,, as defined in equaion (1). On nonannouncemen days he ime series are assigned a value of 0. Given he sheer number of announcemens a useful way of reducing he dimensionaliy of he announcemens variables, while preserving he essenial informaion conen of he surprise series, is o recursive esimaes of he mean surprise based on fed funds fuures are no saisically differen from zero afer he end of Beween Augus 1997 and April 1999, Fed direcives announced a numeric value of he inended fed funds rae. Since May 1999, he Fed issues a press saemen following each FOMC meeing. In February 2000 he Fed replaced is policy bias saemen wih announcemen suggesing a balance of risks. 16 Indeed, while he covariance beween he wo ime series is negaive in he wo samples, i is almos 16 imes larger on policy seing days han on non-meeing days. 21

24 resor o a principal componens analysis. This was done for he vecor of announcemens for each counry separaely. This approach permis us o reduce he effecive number of announcemens o 12. Table 1 provides summary saisics as well as lising he individual announcemens ha receive he highes weighs. For he US and he U.K., hree principal componens were found while wo principal componens characerize he daa for Germany, Japan, and he euro area. Several of he US sudies cied earlier also find ha he producer price index, payroll daa and hours worked are salien announcemens bu, as can be seen from Table 1, several oher major economic announcemens also maer. Table 1 abou here More generally, wih he excepion of he EU, announcemens abou price and oupu developmens are clearly he mos imporan hough we noe, imporanly, ha he widely repored IFO business climae index is among he announcemens ha included among he principal componens. Also ineresing o noe is he fac ha here is an asymmery of sors over he sample considered in ha he average sandardized values of he principal componens of he announcemens is posiive wih he noable excepion of Japan, where i is negaive. Generally, he disribuion of he sizes of he surprises is fairly similar across counries hough he U.K. and he US have experienced a small number of relaively large negaive announcemens and, wih he excepion of Japan, he fracion of bad news announcemens is larger han for he eurozone or European Union The eurozone and European Union are no he same bu i was no always clear from he daa which geographical region he announcemen refers o. 22

25 We conclude by briefly describing some of he more qualiaive variables. Several feaures of he daa readily sand ou. Firs, while he ECB regularly commens on he euro exchange rae, no comparable saemens could be found in Federal Open Marke Commiee saemens. Second, during he period considered, he Federal Open Marke Commiee did no provide an oulook for fiscal policy or he exchange rae (a leas he Euro-US-dollar exchange rae). Third, he ECB produced no only relaively more commenary abou he oulook for inflaion bu i did so more inensively han he Fed. On he oher hand, boh cenral banks regularly commened on real economic developmens (viz., oupu and oupu growh). The same is rue for commenary abou he oulook based on foreign developmens (viz., primarily he US, bu also Asia). Lasly, here was relaively lile menion by eiher cenral bank abou asse prices, alhough he ECB became relaively more alkaive beginning in Finally, Figure 4 provides some informaion abou he conen of he Reuers poll of expecaions regarding he ECB reference rae. We compare he expeced size of ECB reference rae changes o he acual changes made in he ECB s main refinancing operaions rae since The expeced value simply represens a weighed average of poll respondens views abou he likely value of he ECB s policy rae where he weighs are he fracion of respondens who anicipaed eiher no change, a 25 bp rise or fall, or a 50 bp rise or fall, hese being he caegories used in he poll. Figure 4 abou here 18 One should no conclude, of course, ha while he Federal Open Marke Commiee was less vocal, in erms of he frequency of uerances abou asse price developmens, ha is words had less impac. The opposie could well be correc. 23

26 The Figure reveals ha, in 2000 and 2001, he Reuers poll paricipans largely prediced he direcion of change in he ECB s key rae even if hey somewha underesimaed he size of he change. The same is generally rue of expecaions afer 2001, wih expeced changes seling very close o zero by he end of 2003, when he ECB ceased o change is policy rae, a leas unil he end of our sample. Neverheless, here is considerable volailiy in expeced changes in he ECB policy rae based on he polling daa. In he empirical work o follow we make use of his and oher feaures noed above o deermine wha drives he Euro-US-dollar exchange rae since 1999 and he role of ECB spoken words. 6. Empirical Resuls Table 2 shows a selecion of coefficien esimaes from equaion (3) and (11). A oal of 31 differen definiions for MP were considered. Due o he possibiliy of endogeneiy discussed earlier, we firs conduced a Hausman es on he mean equaion. 19 Resuls (no shown) sugges ha OLS esimaes are inconsisen (ha is, he null of unbiasedness and consisency is rejeced) unless equaion (3) is condiioned on he principal componens of news and our proxy for ECB saemens. However, when 19 This consiss in esimaing equaion (3) and esimaing an auxiliary equaion where he residuals from (3) ener as a separae regressor. If he esimaed coefficien is saisically significan, hen he null of consisency of OLS coefficien esimaes is rejeced. 24

27 equaion (3) includes boh of hese variables he Hausman es rejecs he null of consisency in only 4 of 31 definiions for MP examined. 20 Table 2 abou here Table 2 reveals ha saemens ha specifically focus on exchange rae developmens are he only ones ofen, hough no always, found o be saisically significan. We also experimened wih a proxy for he impac of ECB saemens ha aggregaes all of he 5 caegories of saemens defined above bu his variable is insignifican in he various regressions. This suggess ha here is some added value in disaggregaing saemens according o he economic variable being discussed by he cenral bank. Furher, commenary by he ECB concerning he Euro-US-dollar exchange rae is always found o produce a depreciaion of he euro. In conras, commenary abou asse prices (usually sock prices bu, occasionally, also housing prices) leads o an appreciaion of he euro. Indeed, he effec of hese saemens is seen as essenially offseing hose ha specifically deal wih he exchange rae. Hence, previous sudies purporing o show ha news evens have relaively small effecs in levels a he daily frequency may have reached such a conclusion because hey did no sufficienly disaggregae he source of news. The coun variable ha proxies he inensiy wih which repors abou he euro and ineres raes in he euro area are repored in he media is also saisically significan, and 20 They are he wo week eurepo rae, he 12 monh, 9 monh, and overnigh euro area-us ineres rae differenial. When only C appears in (3), OLS is inconsisen in all 31 cases. When news (i.e., Z ) only appears in he regression he null of consisency of OLS esimaes is rejeced in 19 of 31 cases considered. 25

28 always negaive, in 4 of he 6 cases repored in Table 2. Therefore, more frequen reporing of news iems dealing wih MP and Δ e leads o an appreciaion of he currency, hough he coefficien is relaively small. Three oher resuls are noeworhy. Firs, as heory would predic a rise in euro area ineres raes or in he euro area-us ineres differenial leads o an appreciaion of he euro in all bu one case shown in he Table. Moreover, a longer mauriies, such as one year, he impac of ineres rae changes on he exchange rae dwarfs hose from ECB saemens by a wide margin. I is also worh noing ha a rise in he implied volailiy of foreign exchange opions, an indicaion ha markes are bearish abou he euro, is indeed seen as leading o a depreciaion of he currency. Second, US ineres rae developmens also impac separaely on he rae of change in he Euro-US-dollar exchange rae. The esimaed coefficiens can only be undersood as an indicaion ha conemporaneous increases in some US raes, in paricular Libor raes se in London, lead o an expecaion of higher euro area raes and hence o a curren appreciaion of he euro. Third, in half he cases shown, esimaes of foreign exchange reserves published by Reuers are significan wih he negaive sign implying ha posiive foreign exchange reserve growh porends an appreciaion in he euro, presumably because accumulaing reserves can hen serve as a means o raise he value of he euro currency. Turning o he EGARCH(1,1) esimaes we find ha in over half he cases shown, paricularly ones ha focus on he oulook for he euro, ECB saemens lead o a diminuion of exchange rae volailiy. This suggess ha such saemens can be consrued as being informaive in he sense ha hese reduce he risks surrounding exchange rae developmens. An increase in he frequency of news coun dealing wih 26

29 exchange rae and ineres rae developmens is also seen as reducing exchange rae volailiy and he same resul holds for posiive growh in foreign exchange reserves. In boh cases, however, he coefficiens are much smaller han hose capuring he impac of ECB commenary and ineres raes on exchange rae volailiy. Finally, i is ineresing o observe ha saemens from he FOMC, consruced in he same manner as he ones used o consruc he proxies for ECB communicaions aciviies, have almos no separae impac on he euro/usd exchange rae. Nex, we urn o he resuls of he Rigobon-Sack (2004) procedure. Table 3 presens coefficien esimaes for a seleced se of definiions for MP. Four separae definiions of policy (P) and non-policy days (NP) are considered. They are he days when he ECB s Governing Council mees, he day before hese same meeings, 21 days when he ECB Presiden delivers a speech abou developmens and prospecs concerning he euro exchange rae, and days when he FOMC mees o se he arge for he fed funds rae. Table 3 abou here Esimaes of θ are saisically significan in almos all cases when P is defined as he day before he Governing Council mees while α is generally insignifican. Therefore, communicaion has a significan effec on he euro exchange rae. This resul, while consisen wih radiional ime series model esimaes shown above, also highlighs he crucial disincion beween policy and non-policy days. By conras, no saisically reacion was found when P consiss of days when he ECB ses is policy raes or when he Federal Open Marke Commiee mees in Washingon (no shown). Only a handful 21 This mainly, hough no always, coincides wih he release of he Reuers poll of ineres rae expecaions. 27

30 of coefficiens are saisically significan when P includes days when he ECB Presiden delivered speeches ha deal wih he oulook for he euro area (no shown). The cases highlighed in bold characers are he ones where an earlier Hausman es rejeced he consisency of OLS esimaes suggesive of he endogeneiy of MP and Δ e. Focusing on days when P is defined as he day before Governing Council meeings we conclude ha ECB saemens lead o a depreciaion of he exchange raes. Turning o he impac of MP and Δ e we ypically find ha igher policies lead, as would be expeced, o an appreciaion of he euro bu only one saisically significan insance is found. The column labelled p H gives he p-value for he Hausman es of he null ha he heeroskedasic and even sudy esimaors are equal. 22 Rejecions of he null, ha is, he assumpion used in even sudies, occur only when MP is measured by a euro area-us ineres rae differenial. Overall, he ime series, even sudy, and Rigobon-Sack procedures highligh he imporan role ha cenral bank communicaion can play. However, he heeroskedasiciy based idenificaion procedure emphasizes ha he iming of communicaion plays a significan role in wheher a saisically significan link beween communicaion and he exchange rae. 7. Conclusions This paper has presened esimaes of he impac of ineres raes and ECB communicaion policies on he Euro-US-dollar exchange rae. We inroduce a new indicaor of ECB communicaions policies ha focuses on wha he ECB says abou he 22 P-values are given for one case only as hey are broadly similar for he oher definiions of P and NP considered. 28

31 fuure economic oulook for he euro area along 5 differen economic dimensions. Time series and even sudy approaches are employed, as well as he heeroskedasiciy esimaor proposed by Rigobon and Sack (2004). Three broad conclusions emerge. Firs, he impac of ECB communicaions policies is more apparen in he ime series framework han in he heeroskedasiciy esimaor approach. Second, previous sudies ha conclude ha news effecs are significan a he daily frequency may have reached such a conclusion because he measuremen of news was oo highly aggregaed. When news effecs are disaggregaed hey are ofen found o be individually saisically significan. Third, he endogeneiy of he exchange raeineres rae relaionship is more apparen when he proxy for moneary policy is he euro area-us differenial han when any oher proxy for moneary policy is employed. Finally, ineres rae changes generally have a much larger impac on exchange rae movemens, and heir volailiy, han do ECB verbal pronouncemens. As a resul, policy deeds can be inerpreed as having a bigger impac on he euro han policy words. Poenial limiaions of our sudy include he focus on daily daa, and he omission of rading volume informaion. While i is unclear, based on exising published esimaes, wheher hese would overurn our resuls, fuure research ough o invesigae hese possibiliies more fully. I would also be ineresing o deermine in a more rigorous fashion wheher he resuls presened here are robus o differen mehodologies o inerpre and codify cenral bankers words. These exensions are lef for fuure research. 29

32 References Andersen, T. G., T. Bollerslev, F. X. Diebold, and C. Vega (2005), Real-Time Price Discovery in Sock, Bond and Foreign Exchange Markes, NBER working paper Andersen, T. G. and T. Bollserslev (1998), Deusche Mark-Dollar Volailiy: Inraday Aciviy Paern, Macroeconomic Announcemens, and Long-Run Dependencies, Journal of Finance 53, Bernanke, B. S., T. Laubach, F. Mishkin, and A. Posen (1999), Inflaion Targeing: Lessons from he Inernaional Experience (Princeon: Princeon Universiy Press). Beine, M., G. Janssen, and C. Lecour (2004), Should Cenral Bankers Talk o he Foreign Exchange Markes?, working paper. Bini Smaghi, L. (2006), Dealing wih he New Gians, speech given 4 May, Geneva, Swizerland, available a Bohl, M. T., P. L. Siklos, and T. Werner (2006), Do Cenral Banks Reac o he Sock Marke? The Case of he Bundesbank, Journal of Banking and Finance forhcoming. Buchan, D. (2005), Enemy of Inflaion Who Seered Euro, Financial Times 31 July, available a Campbell, J. Y., A. W. Lo, and A. C. Mackinlay (1997), The Economerics of Financial Markes (Princeon: Princeon Universiy Press). Canova, F. and G. DeNicolo (2000), Term Srucure, Inflaion and Real Aciviy: An Inernaional Perspecive, Macroeconomic Dynamics 4,