Central Bank Communications – working?

FRBSF economists Puneet Chehal and Bharat Trehan have a nice short paper on Central Bank communications in this crisis.

Bank of Canada has promised to keep its interest rate low till second quarter of 2010 but Fed just says for an extended period. Hence BoC is more specific but Fed is vague. Does explicitiy help BoC? Not really.

As part of their efforts to promote economic recovery, some central banks have announced they will not raise policy rates for specified time periods. Other central banks have not been as explicit, though they have provided guidance. A comparison of the effects of the Bank of Canada’s conditional promise to hold rates steady through the second quarter of 2010 with the Federal Reserve’s less explicit guidance finds no evidence that market participants make distinctions between these statements.

However, the reasons are not that BoC is less credible but because inflation outlook has changed.

The Bank of Canada’s commitment to leave rates unchanged did affect interest rates initially, but the effect does not appear to have persisted. Market participants expect the Bank to raise rates as the economy strengthens. This doesn’t necessarily mean the Bank is not credible. It has stressed that its commitment is conditioned on the inflation outlook. At the same time, U.S. and Canadian forward rates are closely correlated on either side of the commitment’s expiration date. So we find little to suggest that the announcement of a fixed end date has significantly affected expectations of future monetary policy in Canada. It seems that market participants see little difference between the U.S. phrase “extended period” and Canada’s conditional commitment to keep rates fixed for a specified period.

Hmmm… Interesting stuff.

One Response to “Central Bank Communications – working?”

  1. Bank of Canada removes conditional commitment « Mostly Economics Says:

    […] an interesting study by Puneet Chehal and Bharat Trehan of FRBSF, the authors ask whether BoC explicit commitment […]

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