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02.07.2009
Inflationary pressures to remain low
Today the ECB’s held its monthly press conference. This conference is of keen interest to market participants and scholars from all over the world as it provides a detailed and timely explanation of the ECB’s monetary policy decisions. It is used to infer on the future stance of monetary policy in the euro area. The ECB itself highlights that “The introductory statement at the monthly press conference is the principal vehicle of the ECB’s communication.” (ECB Monthly Bulletin, April 2007). An important aspect is that it conveys the collective view of the Governing Council.
Among scholars as well as officials, central bank communication is seen as an important and powerful tool to guide the markets, enhance the predictability of monetary decisions and improve the effectiveness of monetary policy making. To be able to test its importance and effectiveness economists try to quantify central bank communication.
Several indicators have been proposed to capture the communication of the monetary authority accurately. They range from highly reproducible objective word count indicator to highly subjective indicators coded by authors themselves.
The previous approaches of quantifying the ECB’s communication were either based on dummy variables (see, e.g., Jansen and de Haan, 2007, Ehrmann and Fratzscher, 2009) or specific code words (see, e.g., Heinemann and Ullrich, 2007) and, hence, too mechanical for appropriately capturing its content or based on the subjective interpretations of a few selected economists (see, e.g., Berger et al., 2006) and, hence, lacked objectivity and were hard to reproduce. The KOF MPC tends to incorporate the merits of both: objective, reproducible and capturing as much information as possible.
To do this we commissioned Mediatenor to analyse the press release using content analysis.
Each sentence has been split up into several ‘information units’ which then have been categorized according to the topic that is addressed (prices, growth, etc.), the tense of the statement (past, present and past, present, present and future, future) and the tendency of development (decrease, no change, increase). For our purpose we extract information on the real economy, prices, money growth and the exchange rate. For each of these topics we calculate a communication indicator which reflects the ECB’s expectations concerning rising relative to falling values. Since our intention is to construct forward looking measures, we solely use statements with tense categorized as present and future or future. For the KOF MPC we consequently only consider forward-looking statements on price movements. By subtracting the share of statements which suggest a declining pressure on price stability from that pointing towards increasing pressure, the final indicator is by construction bounded between -1 and +1.
The figure above shows both, the KOF MPC as well as the ECB’s key interest rate, the marginal refinancing rate. Based on cross correlation coefficients, the KOF MPC leads changes in the main refinancing rate by about two months. This is in line with the idea that especially the forward-looking statements of the ECB concentrating on price stability are intended to prepare markets for upcoming changes.
The KOF MPC has already been used to investigate the impact of central bank communication. Conrad and Lamla (2006) find that ECB communication as proxied by the KOF MPC moves exchange rates in the expected direction. If the ECB communicates that future inflation will increase, the implied expected increase in the interest rate will cause the Euro to appreciate against the US dollar
Furthermore, Sturm and De Haan (2009) have recently included the KOF MPC into a Taylor rule and test the explanatory and predictive power of the KOF MPC. They conclude that the KOF MPC indeed is statistically significant and remains so independent of other explanatory variables included. Moreover, it improves the accuracy of the interest rate forecast.
Given its characteristics and the fact that it is always published shortly after the introductory statement of the Governing Council has been released, the KOF MPC has turned into an attractive quantification of the communicated future monetary policy stance by the ECB.
The KOF Monetary Policy Communicator (KOF MPC) quantifies the risks to future price stability as communicated by the ECB via its Introductory Statements released after the Governing Council meetings. It is published by the KOF Swiss Economic Institute on the days of these Introductory Statements at 5.30pm cet.
For further details visit also: http://www.kof.ethz.ch/ ________________________________________________ References:
Berger, H., J. de Haan und J.-E. Sturm (2006). Does money matter in the ECB strategy? New evidence based on ECB communication. KOF Working Papers No. 125.
Conrad, C. and M. J. Lamla (2007). The high-frequency response of the EUR-US Dollar ex-change rate to ECB monetary policy announcements. KOF Working Papers No. 174.
Ehrmann M. and M. Fratzscher, (2009)."Explaining Monetary Policy in Press Conferences," International Journal of Central Banking, International Journal of Central Banking, 5, 42-84.
Heinemann, F. und K. Ullrich (2007). Does it pay to watch central bankers’ lips? The information content of ECB wording. Swiss Journal of Economics and Statistics. 143, 155–185.
Jansen, D.-J. and J. de Haan, (2007). Were verbal efforts to support the Euro effective? A high-frequency analysis of ECB statements. European Journal of Political Economy, 23, 245–259.
Sturm, J.-E. and J. de Haan (2009) Is central bank communication really informative when forecasting interest rate decisions? New evidence based on a Taylor rule model for the ECB, mimeo.
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