Monetary Policy Surprises Research Articles

Fed and ECB: which is informative in determining the DCC between bitcoin and energy commodities?

PurposeThis paper provides an important perspective to the predictive capacity of Fed and European Central Bank (ECB) meeting dates and production announcements for the dynamic conditional correlation (DCC) between Bitcoin and energy commodities returns and volatilities during the period from August 11, 2015 to March 31, 2018.Design/methodology/approachTo assess empirically the unanticipated component of the US and ECB monetary policy, the authors pursue the Kuttner's approach and use the federal funds futures and the ECB funds futures to assess the surprise component. The authors use the approach of DCC as introduced by Engle (2002) during the period from August 11, 2015 to March 31, 2018.FindingsThe authors’ results suggest strong significant DCCs between Bitcoin and energy commodity markets if monetary policy surprises are incorporated in variance. These results confirmed the financialization of Bitcoin and commodity energy markets. Finally, the DCC between Bitcoin and energy commodity markets appears to respond considerably more in the case of Fed surprises than ECB surprises.Originality/valueThis study is a crucial topic for policymakers and portfolio risk managers.

The response of precious metal futures markets to unconventional monetary surprises in the presence of uncertainty

AbstractThis article examines the relationship between the unconventional monetary policies and precious metal futures markets by employing an asymmetric conditional volatility specification. The results suggest that the Fed announcements that likely induced lower long‐term yields on average led to significant increases in the returns, while the effect of the ECB's unconventional monetary announcements is much weaker. Also, monetary policy surprises from both Fed and ECB have larger effects on gold return volatility. Moreover, while there are no asymmetric return responses to positive and negative surprises embedded in the monetary policy from the Euro zone, the return reactions of price returns to surprises in Fed's announcements exhibit asymmetry. Furthermore, our analysis shows that the volatility reactions are limited to negative surprises. Finally, we find evidence that the response of gold price changes to monetary announcements by the Fed becomes weaker in the presence of monetary policy uncertainty. We show also that the response of precious metal returns hinges on the sign of the unexpected component of Fed announcements.

Stock market bubbles and monetary policy effectiveness

In this paper, we provide evidence on the role of conventional monetary policy in the dynamics of stock market bubbles. We analyze the response of stock market returns to monetary policy shocks but condition the analysis on both the direction of monetary policy surprises and business conditions. Following a two-step approach, we first use a structural vector autoregressive (SVAR) model to identify a proxy variable of monetary policy shocks, and then we apply a conditional regression to contemporary stock market returns and these monetary policy shocks to extract the implicit relationship between these variables in different scenarios. Our results show that monetary policy does not impact on stock market returns in a significant form in the scenario defined by positive shocks and expansion periods, i.e. the lower effectiveness of restrictive monetary policy shocks coincides with the phase of the business cycle in which bubbles arise.

The International Spillover Effects of US Monetary Policy Uncertainty

An extensive literature studies the international transmission of US monetary policy surprises (shifts in expected path of the policy rate). In this paper we show that changes in uncertainty around the expected path constitute an important additional dimension of spillover effects to global bond yields. In advanced countries, it is the term premium component of yields that responds to uncertainty. We find that this can be explained by an international portfolio balance mechanism. In contrast, for emerging countries it is the expected component of yields that reacts to uncertainty. This can be rationalized from a flight to safety channel. We find heterogeneity in the country-level response to uncertainty only in emerging economies and it is driven by the degree of financial openness. Finally, equity markets in both advanced and emerging countries also respond to US monetary policy uncertainty, but only since the financial crisis.

Monetary Policy Uncertainty and Monetary Policy Surprises

Monetary policy uncertainty affects the transmission of monetary policy shocks to longer-term nominal and real yields. For a given monetary policy shock, the reaction of yields is more pronounced when the level of monetary policy uncertainty is low. Primary dealers and other investors adjust their interest rate positions more when monetary policy uncertainty is low than when uncertainty is high. These portfolio adjustments likely explain the larger pass-through of a monetary policy shock to bond yields when uncertainty is low. These findings shed new light on the role that monetary policy uncertainty plays in the transmission of monetary policy to financial markets.

What Happens When Equity Investors Disagree with the FOMC?

This research explores an alternative explanation for the equity premium associated with Federal Open Market Committee (FOMC) announcement days that accounts for a sizable fraction of annual equity returns. My evidence shows that investor expectations formulated prior to FOMC announcements have a significant impact on equity prices, particularly when these expectations are not aligned with the FOMC decision. Furthermore, I document an even larger impact around FOMC announcements where the level of interest rates remained unchanged. When monetary policy is neutral, the observed investors’ disagreement towards the FOMC decisions represents a further layer of uncertainty in the dynamics of equity markets. My results reconcile past findings on the monetary policy surprise literature and more recent empirical findings on the effect of FOMC announcements, which are difficult to explain with standard asset pricing theories. Moreover, as I find little effects on equity returns when the FOMC decision is anticipated by the market, a practical implication of my study is that monetary policy authorities should take into account market expectations when formulating disclosure policy in order to improve alignment with financial market expectations and smooth out their economic consequences.

Impact of monetary policy on the Indian stock market: Does the devil lie in the detail?

Although the link between the stock market and monetary policy is nebulous in the Indian context, it is perceived to be significant in popular perception. Towards explaining this disconnect, we probe the impact of Indian and US monetary policy announcements on disaggregated sectoral stock indices using the identification through heteroscedasticity approach. Our findings suggest differential impact of monetary policy on stocks across sectors. Illustratively, in terms of monetary policy surprises, the impact on the stocks of banking and financial services as well as the realty sector turns out to be significant. In contrast, sectors like media, metal, pharmaceuticals, information technology or fast moving consumer goods are found to be unresponsive. Interestingly, US unconventional monetary policy (quantitative easing) measures are found to have an impact on fast moving consumer goods and the media sector. These findings are attributed to: (1) dominance of the bank lending channel; (2) predominance of public sector vis-a-vis private banks; (3) significant influence of monetary policy on demand for housing and automobiles; (4) relative ineffectiveness of the asset-price channel of monetary transmission; and (5) sector-specific affects arising out of financial liberalisation.

Inquiry on the transmission of U.S. aggregate shocks to Mexico: A SVAR approach

We analyze the business cycle co-movement between Mexico and the US. We identify two shocks affecting US aggregate supply, three affecting its demand, and two types of monetary policy surprises with different financial implications. US shocks explain about 75% of expected output fluctuations in Mexico at a three-year horizon, with US demand shocks driving half of these variations alone. In turn, Mexican output responses to a monetary policy surprise in the US depend on the reaction of investors’ sentiment to said surprise. Finally, for the sample period studied, financial-market interconnections are as important as goods-demand linkages for the international transmission of US shocks.

Monetary policy transmission in the United Kingdom: A high frequency identification approach

This paper investigates the impact of monetary policy shocks on macroeconomic and financial variables in the United Kingdom using a new series of high-frequency monetary policy surprises. Employing our surprises as an instrument in a monthly SVAR over the UK’s inflation-targeting period, we show that a monetary policy tightening induces a decline in economic activity and in CPI, an appreciation of the Pound, a reduction in bank credit, and a significant increase in mortgage and corporate bond spreads. UK monetary policy also affects foreign credit spreads, consistent with the extensive presence of large international players in the UK financial intermediation sector. We finally propose a novel test of overidentifying restrictions, which exploits the availability of the narrative series of monetary policy shocks constructed by Cloyne and Hurtgen (2016), and find that our high-frequency monetary policy surprises are not significantly affected by non-monetary news.

Monetary Policy Surprises and Exchange Rate Behavior

Central banks unexpectedly tightening policy rates often observe the exchange value of their currency depreciate, rather than appreciate as predicted by standard models. We document this for Fed and ECB policy days using eventstudies and ask whether an information effect, where the public attributes the policy surprise to an unobserved state of the economy that the central bank is signaling by its policy may explain the abnormality. It turns out that many informational assumptions make a standard two-country New Keynesian model match this behavior. To identify the particular mechanism, we condition on multiple asset prices in the eventstudy and model implications for these. We find that there is heterogeneity in this dimension in the eventstudy and no model with a single regime can match the evidence. Further, even after conditioning on possible information effects driving longer term interest rates, there appear to be other drivers of exchange rates. Our results show that existing models have a long way to go in reconciling eventstudy analysis with model-based mechanisms of asset pricing.

Monetary Policy Surprises and Inflation Expectation Dispersion

Monetary Policy Surprises and Inflation Expectation Dispersion

Monetary Policy Surprises and Corporate Credit Spreads

We study the effects of monetary policy surprises (MPSs) on corporate credit default swap (CDS) spreads. Using high-frequency surprises around Federal Open Market Committee (FOMC) announcements, we find a negative relation between changes in unexpected expansionary monetary policy and changes in CDS spreads using both panel regressions and time-series regressions. More importantly, we show that there is a strong cross-sectional effect of MPSs on CDS spreads. Unexpected expansionary monetary policy reduces the flight-to-safety and flight-to-liquidity phenomenon: The credit spread between investment-grade and high-yield CDSs narrows significantly following an unexpected monetary policy. Finally, we show that monetary policy affects CDS spreads through cash flow, financial constraints, and risk channels.

Monetary Policy Surprises and Exchange Rate Behavior

Central banks unexpectedly tightening policy rates often observe the exchange value of their currency depreciate, rather than appreciate as predicted by standard models. We document this for Fed and ECB policy days using event-studies and ask whether an information effect, where the public attributes the policy surprise to an unobserved state of the economy that the central bank is signaling by its policy may explain the abnormality. It turns out that many informational assumptions make a standard two-country New Keynesian model match this behavior. To identify the particular mechanism, we condition on multiple asset prices in the event-study and model implications for these. We find that there is heterogeneity in this dimension in the event-study and no model with a single regime can match the evidence. Further, even after conditioning on possible information effects driving longer term interest rates, there appear to be other drivers of exchange rates. Our results show that existing models have a long way to go in reconciling event-study analysis with model-based mechanisms of asset pricing. Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Monetary Policy Surprises and Exchange Rate Behavior

Monetary Policy Surprises and Exchange Rate Behavior

Systemic Importance of Central Bank Communication: ECB Policy Announcements and Systemic Risk in the Eurozone

This paper studies central bank communication of the ECB as a potential factor that explains the contribution to systemic risk for a panel of large banks in the Eurozone between 2002 and 2018. The empirical evidence suggests that the ECB is able to use central bank communication to effectively steer private sector expectations in such a way that it has a robust and significant impact on banks' contribution to systemic risk. However, the results indicate that this influence varies over time, implying that the ECB uses monetary policy surprises and the associated language to steer market expectations in line with its own policy objectives at time. Additional analyses show that banks that contribute more to systemic risk tend to be more sensitive towards the effects of central bank communication. More specifically, larger banks and highly leveraged banks react more strongly to central bank communication. Furthermore, requirements of prudential regulation tend to mitigate the effects of central bank communication which is additional evidence on the topic of policy coordination between macroprudential policy and monetary policy.

Euro Area Periphery Countries’ Fiscal Policy and Monetary Policy Surprises

In this study, we explore how fiscal policy in euro area periphery countries responds to monetary policy surprises that lower sovereign bond yields. In particular, we assess whether the disciplining effect of financial markets on public finances is undermined by the ability of monetary policy to affect the conditions of external funds. Using Jorda’s (2005) local projection method we find that fiscal discipline, on average, does not wane in response to monetary policy innovations that bring down yields on sovereign bonds. The reaction of economic activity to shocks to monetary policy appears to determine the fiscal stance, rather than the adjustment of borrowing cost.

Monetary and Macroprudential Policy Complementarities: Evidence from European Credit Registers

We show strong complementarities between monetary and macroprudential policies in influencing credit. We exploit credit register data - crucially from multiple (European) countries and for both corporate and household credit - in conjunction with monetary policy surprises and indicators of macroprudential policy actions. Expansive monetary policy boosts lending more in accommodative macroprudential environments. This complementary effect of monetary and macroprudential policy is stronger for: (i) expansionary (as opposed to contractionary) monetary policy; (ii) riskier borrowers; (iii) less capitalized banks (especially when lending to riskier borrowers); (iv) consumer and corporate loans (rather than mortgages); and (v) more (ex-ante) productive firms (especially for less capitalized banks).

Banking Supervision, Monetary Policy and Risk-Taking: Big Data Evidence from 15 Credit Registers

We analyse the effects of national versus supranational banking supervision on bank risk-taking, and its interactions with monetary policy. For identification, we exploit: (i) a new, proprietary dataset based on 15 European credit registers; (ii) the institutional change in European banking supervision; (iii) high-frequency monetary policy surprises; (iv) cross-country difference within and outside the euro area. First, supranational supervision reduces credit supply to firms with high credit risk, but strengthens credit supply to firms without loan delinquencies, especially for banks operating in stressed countries. Results are driven by two mechanisms: the country’s institutional quality where banks operate, and bank-level systemic importance. Second, there are important complementarities between monetary policy and supervision: centralised supervision offsets high credit risk-taking induced by accommodative monetary policy, but not credit supply to more productive firms. Overall, we show that using multiple credit registers – first time in the literature – is crucial for external validity.

A Shadow Rate without a Lower Bound Constraint

We propose a shadow rate that measures the expansionary (contractionary) interest rate effects of unconventional monetary policies that are present when the lower bound is not binding. Using daily yield curve data we estimate shadow rates for the US, Sweden, the euro-area and the UK, and find that they fall (rise) when market participants expect monetary policy to become more expansionary (contractionary), and price this information into the yield curve. This ability of the shadow rate to track the stance of monetary policy is identified on announcements of policy rate cuts (hikes), balance sheet expansions (contractions) and forward guidance, with shadow rates responding timely, and in line with government bond yields. We show two applications for our shadow rate. First, we decompose shadow rate responses to monetary policy announcements into conventional and unconventional monetary policy surprises, and assess the pass-through of each type of policy to exchange rates. We find that exchange rates respond more to conventional than to unconventional monetary policy. Lastly, a counterfactual experiment in a DSGE model suggests that inflation in Sweden would have been around 0.47 percentage points lower had the Riksbank not used unconventional monetary policy since February 2015.

Sectoral Output Effects of Monetary Policy: Do Sticky Prices Matter?

This paper studies the role of sticky prices for the monetary transmission mechanism, using disaggregated industry-level data from 205 US industries. There is substantial heterogeneity in the output responses of industries to monetary policy surprises. I show that an industry's response to monetary policy surprises is systematically related to an industry's degree of price stickiness as measured by the average frequency of price adjustment. The size of the differential reaction is economically large and statistically significant. The results suggest that sticky prices play an important role in the transmission of monetary policy, consistent with New Keynesian macroeconomic models. This result is robust to the inclusion of further industry-level control variables. JEL Classification: E31, E32