FOMC Communication and Interest Rate Sensitivity to News
As central banks make an increasingly greater effort to inform the public about their objectives and operations, it’s important to gain a better understanding of how financial markets could glean information about policy reaction functions from the banks’ communications.
Central bank communications involving forward guidance have received the most attention, because, many studies have shown, they can stimulate demand when nominal interest rates are close to zero, as they have been recently for many advanced economies. Likewise, much of the empirical work on central bank communications has focused on their effect on the level of interest rate expectations.
Less attention has been paid to central bank communications’ ability to convey information about policy reaction functions. This paper takes a step in that direction by exploring the relationship between the language used in communications by the Federal Reserve Open Market Committee (FOMC) and financial market responses to different types of macroeconomic news. Specifically, the author looks at whether the emphasis on the topic of labor in FOMC meeting minutes and post-meeting statements is associated with stronger responses of interest rates to labor-related news. A positive relationship would suggest that FOMC communications could play a role in determining the types of macroeconomic news that the financial markets pay attention to.
- An increased emphasis on labor-related discussion in FOMC meeting minutes and post-meeting statements is positively associated with the extent to which interest rates' response to labor-related news exceeds their response to all other news. The relationship seems to be especially strong for interest rates of longer maturities.
- A similar positive relationship is seen when you focus only on the component of Treasury yields that corresponds to short-term interest rate expectations. This finding indicates that the results are not solely driven by the behavior of term premia, and that FOMC communications are indeed associated with variation in the response of interest rate expectations to different types of macroeconomic news.
This paper’s novel measures of the extent to which FOMC communications were skewed toward labor-related language contributes to an emerging academic literature that seeks to quantify FOMC communications along the dimensions of particular economic topics. One of the methods presented here, based on a multinomial Naive Bayes text classification model with FOMC Greenbooks as source texts for various economic themes, can be readily applied to other topics in FOMC communications.
It isn’t clear whether it’s desirable for FOMC communications to affect financial market variables in the way that they do. One immediate policy implication is that increased central bank discussion of specific economic variables could raise financial market volatility in response to data releases. Because these measures are subject to revisions and temporary anomalies, this increased sensitivity to market variables may not be efficient. Regardless, a better understanding of the effects of FOMC statements and meeting minutes is essential to the design of an optimal communications strategy.
In this paper, I examine whether communications by the Federal Open Market Committee (FOMC) play a role in determining the types of macroeconomic news that financial markets pay attention to. To do so, I construct novel measures of the intensity with which FOMC statements and meeting minutes discussed labor relative to other topics. I find that these labor topic intensity measures are related to the amount by which interest rates’ response to labor-related news exceeds their response to all other news. This relationship is especially strong for interest rates of longer maturities and is also present for short-term interest rate expectations over various horizons.