Communication and Monetary Policy

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 banks 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
k
0
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