Abstract
Central bank communication is becoming a key aspect of monetary policy. How much financial markets listen and, possibly, understand Banco de Mexico's communication on its monetary policy stance should be a key consideration for the central bank to further modernize its monetary policy toolkit. In this paper, we tackle this issue empirically by using our own index of the tone of communication based on Banco de Mexico's speeches and statements and find that money markets do not only listen but they also understand the stance of monetary policy conveyed in the central bank's words. Regarding the ability to listen, first, we find that both the volatility and volume in the money market rates change right after communication from Banco de Mexico's governing body. As for the markets' understanding, we find a statistically significant rise in money market interbank rates the more hawkish communication is. All in all, our results show strong evidence of effective oral and written communication from the Central Bank towards Mexico's money markets.
Highlights
Central bank communication became topical, due the liberalization of financial markets, for mature as well as emerging market countries
We focus on whether money markets listen to the Banco de Mexico by assessing empirically whether central bank communication influences the volatility of financial variables, as in Connolly and Kohler (2004) and Ehrmann and Fratzscher (2007)
The instruments used by the Mexican central bank, which constitute the deeds of monetary policy, are the most important controls since we aim to assess the complementary of words and deeds when conducting monetary policy
Summary
Central bank communication became topical, due the liberalization of financial markets, for mature as well as emerging market countries. In the 1990s, numerous central banks in OECD countries started improving their communication, using different means as a function of their target audience, be it the public or financial markets With respect to the latter, central banks publish their own assessment of the economic outlook and even hints to their future monetary policy action (BIS, 2009; Filardo et al, 2008). Academic research (surveyed by Blinder et al, 2008) has provided increasing evidence that communication represents a powerful tool for central banks to conduct a more predictable monetary policy, the more so the more developed the financial system where such monetary policy is conducted The rationale for such a role of communication lies in the final goal of central bank communication: managing financial markets‟ expectations, which is easier with forward-looking financial markets (Garcia-Herrero & Remolona, 2008). Svensson (2004) emphasized that, “monetary policy is to a large extent the management of expectations.”
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