Formal Pronouncements, Bond Market Volatility, And Central Bank Communication

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This paper presents empirical evidence on one aspect of central bank communication policy - formal pronouncements by central bankers - to better understand whether this channel matters and, if so, what is the nature of the information being
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  Greenspan Shrugs: Formal Pronouncements, Bond Market Volatility, And Central Bank Communication   Robert S. Chirinko Christopher Curran* December 2005 For Presentation At The American Economic Association Meetings January 8, 2006 * Emory University and CESifo, and Emory University, respectively. We are grateful for the comments and suggestions offered by seminar participants at the Bank of England, Deutsche Bundesbank, Ente Einaudi (Rome), and the Sveriges Riksbank and by Torben Andersen, John Curran, Hashem Dezhbakhsh, Amir Kia, Kai Konrad, Jeff Moore, Rose Pianalto, Peter Postl, Huntley Schaller, Alfons Weichenrieder, and especially Helge Berger and Hugo Mialon. Kelli Lanier is thanked for her timely research support. This paper grew out of Ben Carter’s 2000 undergraduate honors thesis; we regret that Ben’s private sector job commitments precluded him from continuing on this project. A substantial amount of the work on this project was completed while Chirinko was a Visiting Scholar at the  Center For Economic Studies , whose research support and hospitality are gratefully acknowledged. Additional critical financial support has  been provided by Emory University’s Institute for Comparative and International Studies under its Research and Program Fund. All errors and omissions remain the sole responsibility of the authors, and the conclusions do not necessarily reflect the views of the organizations with which they are associated.  Greenspan Shrugs: Formal Pronouncements, Bond Market Volatility, And Central Bank Communication Abstract This paper presents empirical evidence on one aspect of central bank communication  policy – formal pronouncements by central bankers – to better understand whether this channel matters and, if so, what is the nature of the information being transmitted. We examine the relationship between three types of pronouncements from Chairman Alan Greenspan -- speeches, testimonies, and FOMC meetings -- and volatility in the 30-year U.S. Treasury bond futures market. We focus on this market because of its sensitivity to monetary policy pronouncements, its substantial effects on real spending, its long-standing establishment (at that time) as the  benchmark long-term Treasury security, its depth, and the availability of market prices at five-minute intervals. By studying the reaction of financial markets, we are able to examine several interesting aspects of the nature of central bank communication policy. Three questions relevant to communication policy are addressed. First, Do these speeches, testimonies, and FOMC meetings (STF’s) matter? We find a strong positive effect, thus rejecting the notions that STF’s are a redundant communication channel or that the bond market is strong-form efficient. We also document that the FOMC meetings are the most potent STF. This systematic link to volatility may reflect that STF’s merely create noise and agitate markets or that they transmit information about the future policy decisions or the state of the economy. We develop a test using a waiting-time variable and reject the noise hypothesis. We then examine the nature of the information. Are STF’s transmitting substantive information or providing a widely-observed costless signal that coordinates bond market activity? We assess the effects of the STF’s 60 minutes before and after the announcement at five minute intervals and uncover evidence in favor of both explanations, though the effects differ across STF's. The quantitative importance of the coordination channel thus highlights the relevance of “global games” and “herding” models for understanding central bank communication. This framework has important policy implications -- pronouncements by the central bank may reduce welfare by overwhelming important private information, thus suggesting that some aspects of the STF’s may be counterproductive.  JEL  Codes: E58 (Central Banks and Their Preferences) G14 (Information and Market Efficiency; Event Studies) Robert S. Chirinko (corresponding author), Department of Economics, Emory University, Atlanta, Georgia USA 30322-2240 PH: 404-727-6645, FX: 404-727-4639, EM: rchirin@emory.edu Christopher Curran, Department of Economics, Emory University, Atlanta, Georgia USA 30322-2240 PH: 404-727-6355, FX: 404-727-4639, EM: econcc@emory.edu  Table of Contents Abstract I. Introduction II. Data And The Basic Estimating Equation III. Do STF’s Matter? IV. Information Or Noise? V. Content or Coordination? VI. Discussion VII. Summary Bibliography Appendix A: Detailed Listing of Speeches, Testimonies, and FOMC Meetings (separate document) Appendix B: Full Set of Regression Estimates (separate document) Tables Figures    Greenspan Shrugs: Formal Pronouncements, Bond Market Volatility, And Central Bank Communication “...the verdict among most, if not all, our ‘watchers’ seems to be that --  broadly speaking -- the ECB has done a good job but has not been very effective in presenting and explaining itself.” Otmar Issing Chief Economist, ECB The Economist   (January 6, 2001, p. 63) “I used to think if there was reincarnation, I wanted to come back as the  president or the pope or a .400 baseball hitter. But now I want to come  back as the bond market. You can intimidate everybody.” James Carville Campaign Advisor to President Clinton Wall Street Journal  (February 25, 1993, p. A1) I. Introduction There is a broad consensus among central bankers and monetary policy scholars that transparency enhances economic performance. Expectations about the future course of the economy and the policy reactions by the central bank have a substantial impact on economic decisions. The lifting of the veil on central banking operations lowers the level of uncertainty confronting firms, households, and investors, and thus enhances incentives for risk-averse agents to undertake long-term commitments. A more transparent monetary policy informs and anchors expectations. With fewer monetary surprises, economic activity becomes less volatile. Moreover, transparency is consistent with the democratic principles of accountability of public institutions to its citizens. 1  While transparency is a widely held goal, how do central banks communicate? As indicated by the above quotation from Otmar Issing, communications is an essential element in 1  See Blinder, Goodhart, Hildebrand, Lipton, and Wyplosz (2001) for a recent lively discussion of transparency, communications, and related issues and references to the literature.   2 the conduct of monetary policy. Blinder et. al. (2001) suggest that, in principle, the central bank should talk about its objectives, its methods for attaining these objectives, and its process of deliberations. There is an extensive literature on the specifics of how central banks should communicate -- explicit announcement of targets, immediate notification of policy decisions,  prompt publication of the transcripts of central bank meetings, and detailed documentation of economic forecasts and the underlying models. One communications channel that has received much less attention is the formal pronouncements made by central bankers. In this paper, we examine this aspect of communication policy, and assess the impact and content of the formal  pronouncements made by Alan Greenspan. Focusing on Greenspan’s “shrugs” affords several advantages. The Chair of the Board of Governors of the Federal Reserve System is one of the most important economic policymakers in the world. His influence has been substantially enhanced by the exceptional performance of the U.S. economy during his long tenure and the perception that the Federal Reserve played a  prominent role in generating this “Long Boom.” Greenspan communicates frequently in three different ways – in speeches to industry groups, academic audiences, and professional associations; in testimony before Congressional committees; and in Federal Open Market Committee (FOMC) decisions. Given the institutional structure and norms of the Board of Governors and his chairing of the FOMC, Greenspan exerts substantial control over monetary  policy. Thus, financial markets are particularly interested in his speeches (S) and testimonies (T) and the outcomes of the FOMC meetings (F). We refer to these formal pronouncements collectively as STF’s. By studying the reaction of financial markets, we are able to examine several interesting aspects of the nature of central bank communication policy. We begin in Section II with a description of the data. We focus on the 30-year Treasury  bond futures market because of its sensitivity to monetary policy pronouncements, its substantial effects on real spending, its long-standing establishment (at that time) as the benchmark long-term Treasury security, its depth, and the availability of market prices at five-minute intervals. Our data are based on a proprietary algorithm that determines the cheapest-to-deliver issue and its price for a given futures contract. The reaction of the bond market to STF’s is evaluated in terms of price volatility (measured by the excess return on bonds) and quantity volatility (measured by trading volume) that represent information flows. The dataset consists of the
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