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Communication and Monetary Policy

Communication and Monetary Policy. Jeffery Amato, Stephen Morris and Hyun Song Shin. Communication and Monetary Policy. Central banks directly control only overnight rate, not prices that matter (long-term interest rates, other asset prices). Expectations determine prices that matter

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Communication and Monetary Policy

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  1. Communication and Monetary Policy Jeffery Amato, Stephen Morris and Hyun Song Shin

  2. Communication and Monetary Policy • Central banks directly control only overnight rate, not prices that matter (long-term interest rates, other asset prices). • Expectations determine prices that matter • Communication shapes expectations(Blinder (1998), Bernanke (2004a, 2004b) • Empirical studies: central bank talk moves markets

  3. Ben Bernanke (October 2004) “the value of more open communication is that it clarifies the central bank’s views and intentions, thereby increasing the likelihood that financial market participants’ rate expectations will be similar to those of the policymakers themselves”

  4. Dual Role of Central Bank • Active, shaper of outcomes, influencing long-term rates, financial market prices • Vigilant observer of events for cues for future actions (in order to be more effective in 1). Does emphasis on (1) detract from (2)?

  5. Two Channels of Transmission • Conveying authoritative information on economic fundamentals and CB intentions • Coordinating role, due to beauty contests in financial markets [other players’ beliefs about (1) matters] • Ill-informed market players can exert influence • Little scope for contrary opinion to find expression

  6. Events of Summer, 2003 Mortgage hedging amplifies beauty contests.

  7. Beauty Contests with Public and Private Information Morris and Shin (AER 2002)

  8. Welfare increase Precision of private signal Precision of public signal

  9. hurdle precision welfare 0 Precision of public information

  10. Welfare Effects of Public Information • Hurdle precision is higher when private information is precise • With cost of acquisition for private information, public information crowds out private information (Tong (2003)) • Welfare loss due to public information is large when private and public signals have common error term (Tong (2004))

  11. Modes of Communication Trade-off between • Quantity of information • Frequent speeches, testimonies by many speakers to possibly fragmented audiences • Degree of common knowledge • Official “platform”, such as inflation report but fewer, less informative disclosures

  12. Semi-Public signals Subset who observe z Morris and Shin (forthcoming)

  13. Choose number of signals m to disclose • Each signal reaches proportion k of population • But k is a decreasing function of m optimum m welfare increase 0 k 1

  14. How important are these effects, really? Effects larger when • Market focuses on others’ anticipation of CB actions • How many employees follow CB speeches rather than do economics research? • Why have so many? For short-term trading or economics research? • Horizon mismatch. When prices are moved by traders with short horizons, prices reveal less about fundamentals

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