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

• Communication shapes expectations (Blinder (1998), Bernanke (2004a, 2004b)

• Empirical studies: central bank talk moves markets

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”

Dual Role of Central Bank

1. Active, shaper of outcomes, influencing long-term rates, financial market prices

2. Vigilant observer of events for cues for future actions (in order to be more effective in 1).

Does emphasis on (1) detract from (2)?

Two Channels of Transmission1. Conveying authoritative information on

economic fundamentals and CB intentions

2. 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

Events of Summer, 2003

Mortgage hedging amplifies beauty contests.

Beauty Contests with Public and Private Information

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Morris and Shin (AER 2002)

Precision of public signal

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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))

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

Semi-Public signals

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Subset who observe z

Morris and Shin(forthcoming)

• Choose number of signals m to disclose

• Each signal reaches proportion k of population

• But k is a decreasing function of m

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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