Is the MCI a Useful Signal of Monetary Policy Conditions? An Empirical Investigation

Abstract

This paper explores some of the potential advantages and disadvantages of monetary policy indicators based on a linear combination of a selected interest rate and the trade‐weighted exchange rate. The resulting measure, called a monetary conditions index (MCI), may provide a means to increase the transparency and credibility of monetary policy but it can also increase confusion among financial market participants if they view the central bank as reacting too closely to every ‘wiggle’ in the MCI.I argue that the aggregation of financial asset prices into an index can have salutary effects on the conduct of monetary policy because it can filter out some of the ‘noise’ in high frequency data. The danger comes from a central bank that stipulates following solely the MCI as a guide to the stance of monetary policy.