Central Bank Communication and Policy Interest Rate

Haryo Kuncoro

doi:10.5430/ijfr.v12n1p76

Abstract

Central bank communications play an important role in the monetary policy. In the inflation-targeting frameworks, central bank communications might guide public to shape inflation expectations and then determine actual inflation rates through which the policy interest rates policy would manage them. This paper studied the impact and central bank monetary policy communications on the policy interest rate. Unlike other studies, this paper uses two stages. First, we estimate the impact of central bank communication on the inflation expectation gap. Second, we use the estimated value of inflation expectation gap to predict the policy interest rate. The study found evidence that economic agents analyse the Governor Board of Central Bank of Indonesia meeting decisions every month to shape their inflation expectation. Therefore, the difference between inflation expectation and actual inflation tends to narrow. The inflation expectation gap affects the policy interest rates in Indonesia. In other words, the policy interest rates can control the inflation rate and anchor expectations as required by the inflation-targeting framework.

Highlights

Monetary policies play an important role in the economy to help in achieving the desired macroeconomic goals
This study departs from a question of whether the central bank communication and the clarity of announcements about the monetary policy influence the formation of inflation expectations so that inflation expectations are the same as actual inflation
We estimate first the influence of the central bank monetary policy communication on the inflation expectations compared to the actual inflation

Summary

Introduction

Monetary policies play an important role in the economy to help in achieving the desired macroeconomic goals. Before 1990, various aspects of the monetary policy decision-making process were largely kept secret (Su et al, 2019). The central bank began to emphasize transparency, especially since the application of rule-based monetary policy. Central bank communication on the monetary policy formulation process and implementation has been increasingly used in managing market expectations (Amato et al, 2002). Central bank communication is a key instrument in the inflation-targeting policy. Since the central bank has to announce the inflation target in advanceand the private sector appraises the future reliability of this target, communication is crucial for the expectation formation process (Svensson, 1999). The usefulness of monetary policy signalling to economic agents in decision-making determines dispersion between the inflation target and the actual inflation

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Conclusion