|
Article Excerpt
CENTRAL BANKS AROUND the globe are pursuing not only different policy objectives, but also vastly different communication strategies. Despite these differences, there is one element that most central banks share, namely, the purdah, that is, the practice of a self-imposed, voluntary guideline to abstain from communicating around policy decisions and other important events. (1) The existence of such a practice is remarkable in several ways. At first sight, it seems to contradict the virtue of transparency that has become the hallmark of virtually all progressive central banks, as it requires withholding information from the public when such information is sought after intensely and would likely affect financial markets substantially.
Why then do central banks pursue such a policy? Remarkably little official information about this practice is provided by central banks. The information that is available indicates that an important rationale for the purdah is the fear that communication just before policy meetings or other important events may create excessive market volatility and "unnecessary speculation" (Federal Reserve 1982, Bank of England 2000), may narrow the options for committees, or may be feared to "dilute" the message of the decision (Federal Reserve 1995).
These arguments underline that under certain circumstances central banks consider communication to be undesirable and therefore limit transparency. The paper assesses this practice for the Federal Reserve, for which a purdah has been in place at least since the early 1980s, nowadays for the 7 days before and 3 days after Federal Open Market Committee (FOMC) meetings, as well as before the chairman's semiannual testimony to Congress.
For our empirical analysis, we are primarily interested in the effect of statements by FOMC members on financial markets during the purdah, and we exploit the fact that such statements do occasionally occur. We find that short-term interest rates react three to four times more strongly to statements reported in the pre-FOMC purdah (immediately before FOMC meetings) than during other times. Statements by FOMC members reported in the pre-FOMC purdah tend to raise market volatility while those in the post-FOMC purdah (in the days following FOMC meetings) or outside the purdah tend to lower volatility. Moreover, these effects are observed primarily at short maturities, indicating that market participants focus more strongly on implications for the current monetary policy stance than for the longer-term outlook for policy in such instances. Finally, the market impact of purdah communication is directly linked to the monetary policy environment in which it occurs. In particular, purdah statements immediately following an FOMC decision that came as a surprise have a substantially larger effect on the level of U.S. interest rates and reduce market volatility much more strongly.
The present paper broadly links to three areas of the literature on monetary policy, transparency, and communication. It sheds light on the role of incomplete, asymmetric or noisy information in central bank communication (see, e.g., the debate between Amato, Stephen, and Shin 2002, Morris and Shin 2002, Svensson 2006, and related work by Orphanides 2003, Rudebusch and Williams 2006, Gosselin, Lotz, and Wyplosz 2007), but also connects to the work on the role of the market environment for transparency to be effective (see, e.g., Eggertsson and Woodford 2003, Bernanke, Vincent, and Sack 2004, Gurkaynak, Brian, and Swanson 2005), and the research on the financial market impact of central bank communication (e.g., Kohn and Sack 2004). But the paper is also distinct in several ways. In particular, the argument presented here in an empirical setting is that there may be important instances when central bank information is vastly superior, but still communication may be welfare reducing and thus such information is withheld, or at least channeled in a specific manner.
1. DESIGN OF THE PURDAH PERIOD AND COMMUNICATION DATA
We commence by defining and describing the purdah practice in this section. The section summarizes the main points of the purdah for the purpose of the empirical analysis below. The interested reader is referred to the extended working paper version (Ehrmann and Fratzscher 2008), which contains a more detailed discussion of the construction of the communication data, quotes of all the statements by FOMC members reported during the purdah and contained in the data set, as well as relevant quotes from FOMC transcripts (Federal Reserve 1982, 1995).
A careful study of...
|
