Essays on monetary policy

This is a summary of the four chapters that comprise this D.Phil. thesis.1 This thesis examines two major aspects of policy. The first two chapters examine monetary policy communication. The second two examine the causes and consequences of a time-varying reaction function of the central bank.
1. Central Bank Communication and Higher Moments
In this first chapter, I investigate which parts of central bank communication affect the higher moments of expectations embedded in financial market pricing.
Much of the literature on central bank communication has focused on how communication impacts the conditional expected mean of future policy. But this chapter asks how central bank communication affects the second and third moments of the financial market’s perceived distribution of future policy decisions. I use high frequency changes in option-prices around Bank of England communications to show that communication affects higher moments of the distribution of expectations. I find that the relevant communication in the case of the Bank of England is primarily confined to the information contained in the Q&A and Statement, rather than the longer Inflation Report.
2. Mark My Words: The Transmission of Central Bank Communication to the General Public via the Print Media
In the second chapter, jointly with James Brookes, I ask how central banks can change their communication in order to receive greater newspaper coverage, if that is indeed an objective of theirs.
We use computational linguistics combined with an event-study methodology to measure the extent of news coverage a central bank communication receives, and the textual features that might cause a communication to be more (or less) likely to be considered newsworthy. We consider the case of the Bank of England, and estimate the relationship between news coverage and central bank communication implied by our model. We find that the interaction between the state of the economy and the way in which the Bank of England writes its communication is important for determining news coverage. We provide concrete suggestions for ways in which central bank communication can increase its news coverage by improving readability in line with our results.
3. Uncertainty and Time-varying Monetary Policy
In the third chapter, together with Michael McMahon, I investigate the links between uncertainty and the reaction function of the Federal Reserve.
US macroeconomic evidence points to higher economic volatility being positively correlated with more aggressive monetary policy responses. This represents a challenge for “good policy” explanations of the Great Moderation which map a more aggressive monetary response to reduced volatility. While some models of monetary policy under uncertainty can match this comovement qualitatively, these models do not, on their own, account for the reaction-function changes quantitatively for reasonable changes in uncertainty. We present a number of alternative sources of uncertainty that we believe should be more prevalent in the literature on monetary policy.
4. The Element(s) of Surprise
In the final chapter, together with Michael McMahon, I analyse the implications for monetary surprises of time-varying reaction functions.
Monetary policy surprises are driven by several separate forces. We argue that many of the surprises in monetary policy instruments are driven by unexpected changes in the reaction function of policymakers. We show that these reaction function surprises are fundamentally different from monetary policy shocks in their effect on the economy, are likely endogenous to the state, and unable to removed using current orthogonalisation procedures. As a result monetary policy surprises should not be used to measure the effect of a monetary policy “shock” to the economy. We find evidence for reaction function surprises in the features of the high frequency asset price surprise data and in analysing the text of a major US economic forecaster. Further, we show that periods in which an estimated macro model suggests policymakers have switched reaction functions provide the majority of variation in monetary policy surprises.

Advisor: McMahon, M