Delphic and Odyssean Monetary Policy Shocks: Evidence from the Euro Area
Working with euro-area data, the authors identify surprises in expected future interest rates that result only from European Central Bank (ECB) communication by looking at the intraday variations in interest rate swap contracts observed in a tight window around the press release and press conference that follow a Governing Council meeting. They present a method for separately identifying two shocks from a single monetary policy surprise observed on the day of a policy decision: a “Delphic” shock and an “Odyssean” shock. The former is news about the future macroeconomic state to which the central bank will react in accordance with its usual policy rule; the latter is news about future deviations from the central bank policy rule given a future macroeconomic state.
The authors show that the coexistence of these two components in central bank communication can explain why announcements about future interest rates lead to a strong reaction by the yield curve and a weak reaction by inflation expectations and stock prices. They document that Delphic and Odyssean shocks have differing impacts on macroeconomic expectations and outcomes as well as financial conditions. A negative Odyssean shock implies a decrease in future interest rates and an increase in stock prices, an increase in the private sector’s forecasts for GDP and inflation, and an increase in activity and prices. A negative Delphic shock also brings a decrease in future expected interest rates but an increase in stock prices, an increase in the private sector’s forecasts for GDP and inflation, and an increase in prices.
The authors consider the reaction of swap contracts of maturities between one month and two years and show that the bulk of the variations in these contracts can be summarized by two factors: a “Target” factor that reflects surprises about the current policy rate and a “Path” factor that conveys news about the path of future interest rates that is independent of the news affecting the current rate.