THE ASYMMETRIC IMPACT OF “INFORMATIVE” AND “UNINFORMATIVE” FEDERAL OPEN MARKET COMMITTEE STATEMENTS ON ASSET PRICES

I. INTRODUCTION Over the past decade, the policy statements issued by the Federal Open Market Committee (FOMC) after each meeting have become an increasingly important element of monetary policy-making in the United States. These statements provide information about the Fed's view on economic outlook, key forces that are likely to shape future developments and potential implications for monetary policy. Therefore, on policy announcement days, market participants monitor closely not only what the Fed does (interest rate decisions), but also what it says (FOMC statements). One striking example is the policy announcement of January 28, 2004, when the Fed kept its target rate unchanged (a move that was widely anticipated by the market), but unexpectedly altered the wording of the statement, causing one of the largest reactions on record in financial markets. Theoretically, central bank communication should not matter to market participants if the central bank is committed to an unchanged policy rule and the public has a perfect understanding of the rule, the objectives, and the thinking of the monetary authority. In reality, the central bank cannot possibly commit to an inflexible policy rule given that the number of contingent states is infinite (Blinder et al. 2008). Consequently, the public needs to estimate the policy function and because the central bank invariably knows more about its future moves, the dissemination of this information is important to market participants. It appears that, at least in practice, market participants should pay attention to the information content of FOMC statements. However, more information does not always translate to greater clarity and ill-conceived statements confuse rather than enlighten. Kahneman (2003) argues that there are limits to how much information can be digested effectively and more information may reduce common understanding among market participants. Moreover, central bank communication may be welfare reducing if agents place too much weight on policy statements and too little on their own information, thus crowding-out private beliefs which are an important source of information for the Fed (Amato, Morris, and Shin 2002; Morris and Shin 2002). In addition, the Fed may increase noise if it communicates information on which it has imprecise knowledge--such as on future economic developments rather than the policy path. This paper contributes to a young but rapidly growing literature on central bank communication by evaluating the impact of the information content of FOMC statements on the level and volatility of Treasuries and stock returns. To measure the "information content," we assess the consensus view about the importance of the statements by collecting news stories from three major news sources right after a policy meeting. This allows us to group statements into two broad categories, "informative" and "uninfor-mative," with informative statements delivering important information which was not previously anticipated by the consensus. A priori, we expect asset prices to respond asymmetrically to the type of information, with informative statements generating a larger response. Figure 1 seems to confirm this idea: the chart plots changes in S&P 500 and Treasury yields around policy announcements with solid bars representing dates when the statement was informative. As seen, the largest asset price changes typically occur when a statement releases important information, which indicates that markets do react to the information content. One reason for this oversized response is that the information delivered by these statements "creates news" in the sense that the content is both important and unexpected. If the news relates to future monetary policy, about which the Fed is expected to possess superior knowledge, then it should have a considerable impact on asset prices. However, statements routinely transmit the Fed's economic outlook which may be interpreted as an additional policy signal because this outlook presumably shapes the future course of monetary actions. …