A model of market surprises
By: Lavan Mahadeva.
Contributors: Bank of England.
Series: Working paper -- no. 327; Working paper (Bank of England : Online) -- no. 327.
Publisher: Bank of England
Published: 2007
Place of publication: London
Language: eng
Format: Electronic resource
Description: "This paper presents a theory to link improvements in transparency about monetary policy  objectives to improvements in transparency about monetary policy actions and then to the  conditional volatility of market expectations of policy rates. Crucially, policy announcements act  not just as an instrument but also as a beacon that can potentially communicate information to  agents about the policymakers' reactions to shocks. When the objectives of policymakers are not  made transparent, agents are more likely to interpret any accommodation to price shocks as  indicating that policymakers are following their own unobserved suboptimal objectives.  Policymakers in these regimes are therefore less inclined to be transparent in their explanations.  Conversely when policy objectives are more clearly defined, policymakers become more  transparent in their explanations too. Then, the less markets will be surprised by interest rate  announcements. I show that happens at a diminishing rate: as transparency is improved further  from already high levels, there is less of a reduction in the variance of market surprises. The  reason is that agents know that they can rely more on the monetary policy beacon in very  transparent regimes. Hence they become more active in their decision-making and policymakers  take that extra sensitivity into account. The model illustrates the gains to having clearly defined  policy objectives. It also explains how a continued occurrence of market surprises, after an initial  large reduction, could be consistent with the greater transparency and more precisely formed  inflation expectations."--Bank of England web site.
Notes: Title from PDF file as viewed on Jan. 28, 2008.

Includes bibliographical references.

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