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.
Key Findings
- The reaction of asset prices to surprises about the current policy rate (the Target factor) is broadly consistent with the typical effects expected from a monetary policy shock. In particular, an unexpected drop in the current target rates lowers future interest rates for as long as three years, increases inflation expectations for as long as three years, and increases stock prices.
- An unexpected lower path of future interest rates that is independent of the news affecting the current rate (the Path factor), lowers expected future interest rates, even for horizons as far ahead as 10 years. However, it also leads to lower expected inflation and has no significant impact on stock market prices, all of which is inconsistent with expectations of future monetary policy shocks.
- Delphic and Odyssean shocks contribute to the Path factor and have very differing impacts on financial conditions. Delphic shocks have comparable effects on the path of future interest rates and on inflation expectations, such that the path of expected real rates remains almost constant. However, Odyssean shocks that move the path of future interest rates downward have a negative impact on expected nominal interest rates and a positive impact on inflation expectations. These impacts are roughly the same for maturities of interest rates and inflation swaps ranging from one to ten years.
- Stock market prices decrease in response to a negative Delphic shock, and they increase in response to a negative Odyssean shock. Moreover, after a negative Delphic shock, corporate borrowing rates decrease by less than the average reaction of risk-free rates, signaling an increase in credit risk. But on average, they decrease more than risk-free rates do after a negative Odyssean shock, implying a decrease in credit risk.
- These shocks affect the private sector’s forecasts of GDP growth and inflation as measured in the Consensus Forecasts survey. Delphic shocks are positively correlated with private forecasts of output and inflation, and Odyssean shocks are negatively correlated with both.
- An unexpected decline in the path of future interest rates generates a drop in prices, which suggests a strong signaling effect of central bank communication. Consistent with expectations of future accommodation, a negative Odyssean shock generates a drop in the slope of the yield curve and an increase in realized output and prices.
- Overall, these reactions are consistent with Delphic shocks conveying news about the macroeconomic outlook and Odyssean shocks conveying news about future monetary policy shocks.
- The relative weight of Odyssean shocks increased over the period during which the ECB gave explicit forward guidance on future interest rates.
Implications
The authors present a method for isolating future monetary policy shocks in the reaction of the yield curve, and they produce results that suggest a central bank should not look at just the reaction of the yield curve to assess the degree of accommodation or tightening that it provides.
The results also suggest that a central bank can control its communication to financial markets in order to deliver the desired degree of accommodation; that is, the bank can influence the relative weight that the markets attach to Delphic versus Odyssean shocks from its communication. For example, changes in central bank communication policy such as the move to explicit forward guidance modifies what markets predominantly infer from the announcements on the days of policy decisions.
Abstract
What drives the strong reaction of financial markets to central bank communication on the days of policy decisions? We highlight the role of two factors that we identify from high- frequency monetary surprises: news on future macroeconomic conditions (Delphic shocks) and news on future monetary policy shocks (Odyssean shocks). These two shocks move the yield curve in the same direction but have opposite effects on financial conditions and macroeconomic expectations. A drop in future interest rates that is associated with a negative Delphic (Odyssean) shock is perceived as being contractionary (expansionary). These offsetting effects can explain why central bank communication leads to a strong reaction of the yield curve together with a weak reaction by inflation expectations or stock prices. The two shocks also have different impacts on macroeconomic outcomes, such that central bankers cannot infer the degree of stimulus they provide by looking at the mere reaction of the yield curve. However, changes in their communication policy can influence the way markets predominantly understand communication about future interest rates.