Overconfidence of the chair of the Federal Reserve and market expectations: Evidence based on media coverage

Abstract

AbstractThis paper examines the relationship between the overconfidence expressed by the chair of the US Federal Reserve and financial market expectations. I first use a media‐based proxy to compute a measure of Fed chair's overconfidence for the period 1999M01–2017M07, the overconfidence indicator. The overconfidence indicator provides a quantitative measure of the overconfidence expressed by the Fed chair, which is covered by the media, and thus, perceived by financial market participants. I relate this variable to inflation and unemployment expectations of market participants. Our results show that an overconfident Fed chair is significantly associated with higher inflation expectations and lower unemployment expectations. These findings are robust to (i) the macroeconomic forecasts used to extract the exogenous component of the media‐based proxy reflecting Fed chair's overconfidence (the Survey of Professional Forecasters and the Greenbook forecasts) and (iii) an alternative proxy of inflation expectations. These findings shed some new light on the impact of central bankers' communication on financial market expectations, and thus, on the effectiveness of their monetary policy decisions.