The impact of news on expectation formation in monetary policy, business cycles and inflation forecasts

Michael Lamla
14 Chapter 2. The Impact of ECB Communication on Financial Market Expectations the target. This implies that communication is used to infer future monetary policy when hard economic data do not reveal clear information of where the path of interest rates is going. The remainder of this chapter is structured as follows. Section 2.2 presents a literature overview. Section 2.3 gives the theoretical foundation for the estimation set-up. Section 2.4 introduces the data and the methodology we
more » ... In Section 2.5 the results are presented and discussed while Section 2.6 draws the conclusions. Literature Overview Especially for a young central bank as the ECB, that is in a process of building up reputation, the central banks' communication catches a lot of interest. There is a broad consensus amongst researchers that central bank communication, by improving credibility and transparency, can enhance monetary policy outcomes and hence welfare. 3 Blinder et al. (2001) distinguish three channels through which clear communication can be welfare enhancing: Firstly, communication can reduce transmission lags of monetary policy actions. The ECB controlled overnight interest rate has an effect on the real economy through inflation expectations. Arguably, a transparent central bank is more credible. This credibility induces wage and price setters to adjust quickly to policy changes. This in turn decreases transmission lags and therefore is beneficial for the effectiveness of monetary policy. 4 Secondly, communication about the long-term inflation goal results in more credibility and thereby in greater trust in the commitment of the central bank to the target. 5 This allows the central bank to be more flexible in their response to shocks in the short-run (King, 1997). As an example, more transparency via clear communication reduces the costs of changes in the policy direction. Central banks usually try to avoid policy reversals, because these reversals may cause confusion about their future policy path. Forward-looking central banks might have to reverse policy decisions in response to other-than-anticipated economic developments. Via clear communication, the central bank ensures that the public understands such a reversal as an optimal response
doi:10.5167/uzh-163693 fatcat:vyvub3cwqzffxplis7yr72rbsi