RDP 2021-04: Monetary Policy, Equity Markets and the Information Effect 7. Beyond Board Meetings

The analysis so far focuses on monetary policy surprises following the monetary policy announcement after RBA Board meetings. This has also been the focus of other work in the literature. However, this does not reflect the only way monetary policy in Australia could be communicated. RBA communication, through speeches or publications, can also be part of the monetary policy toolkit, particularly to the extent that it signals future actions by the RBA. Moreover, these media may contain more information content than the monetary policy announcement following a Board meeting. For example, the RBA's Statement on Monetary Policy (SMP) contains a detailed discussion of economic conditions and the RBA's forecasts of key macroeconomic variables including inflation, GDP and the unemployment rate. International evidence also supports the idea that there is more information conveyed through other central bank communication channels such as press conferences and minutes (Cieslak and Schrimpf 2019). For this reason, it may be important to consider other forms of central bank communication when evaluating the information effect.

Hence, I expand the range of monetary policy tools I consider to also include other RBA communications including the release of RBA Board minutes, the SMP, and speeches by the RBA Governor. To determine the effects of this expanded range of potential monetary policy tools on equity prices and earnings forecasts I recalculate the monetary policy surprises to also include the times of these events. I then re-estimate Equation (3) but allow each type of RBA communication to have a different effect on the dependent variable. That is I estimate:

where I[mpstype = c] is an indicator variable equal to one if the monetary policy surprise is from an event of type c, which includes Board announcements, the SMP release, the release of RBA Board minutes and speeches delivered by the RBA Governor. All other variables are as previously described.

The addition of non-monetary policy announcement events does not appear to result in any large monetary policy surprises, but there is more variation around the GFC (Figure 6). A secondary question is whether these surprises are of a similar nature to the surprises using only the monetary policy announcements. The first factor continues to explain the vast majority of the variation −93.87 per cent – and resembles level shifts in the OIS curve. Hence, it appears that the augmented monetary policy surprises continue to reflect movements in the entire OIS curve.

Looking at the effects of different forms of RBA communication on the ASX 200 provides a more nuanced view of the information effect. Monetary tightening from the release of RBA Board minutes and SMP have negative but insignificant effects on the ASX 200 index (Figure 7). However, monetary policy surprises generated from speeches by the Governor provide some evidence of an information effect. A 100 basis point contractionary monetary policy surprise from Governor speeches causes a 10.4 per cent increase in the ASX 200 index. This result is significant, and runs counter to conventional interpretations of the effects of monetary policy, and provides evidence that it is possible for increases in the OIS curve to result in increases in equity prices, as predicted by the information effect. It is worth noting that the large size of the central estimate does not mean these surprises have been historically important given that the surprises themselves have been small. That is, a monetary policy surprise from a Governor speech is likely smaller than 100 basis points given historical variation.^[13]

Though the responses of the ASX 200 indicates that the information content in speeches delivered by the Governor are potentially high, the results are somewhat weaker when analysing the response of one-year-ahead ASX 200 earnings forecasts (Figure 8). Consistent with the ASX 200 index results, a monetary tightening signalled by a Governor speech results in an upward revision in the one-year-ahead ASX 200 earnings growth forecasts; with a 100 basis point increase in the OIS curve causing around a 7.9 percentage point increase in earnings forecasts. However, this result is statistically insignificant. Taken together with the response of the ASX 200 index, the results suggest there is some evidence to support the notion that other levers of monetary policy, speeches by the Governor in this case, can produce an information effect. However, more work is needed to establish this relationship as the effects on earnings growth are not well identified.

Similar to the ASX 200 index response, one-year-ahead ASX 200 earnings forecasts do not meaningfully respond to monetary policy surprises from the release of the SMP. But, unlike the ASX 200 index response, one-year-ahead forecasted earnings have a meaningful response to monetary policy surprises generated from the release of the RBA Board minutes. The direction of response from the release of Board minutes aligns with conventional interpretations of monetary policy, with a 100 basis point upward shift in the OIS curve driving a downward revision in earnings forecasts of 10.1 percentage points.

Lastly, consistent with the baseline results, the estimates for the long-term earnings forecast are insignificant for all the different types of monetary policy surprises (Figure 8).

Overall, looking across different types of monetary policy communication reveals a more nuanced picture of the effects of monetary policy on equity markets. I find some evidence that the information effect of monetary policy may indeed be present in other communication formats; in this case speeches by the Governor. This is consistent with Cieslak and Schrimpf (2019) who find that there is more information present in central bank communication outside of the policy rate announcement. However, the type of communication matters as other forms of RBA communication (SMP and RBA Board minutes) do not appear to produce responses consistent with the information effect hypothesis, but rather the responses are consistent with standard interpretations of monetary policy or show no effect at all.

7.1 Governor speeches – information or reaction function?

Though the responses from Governor speeches are consistent with the information effect, they may actually be communicating the RBA's policy reaction function. To examine this I re-estimate Equation (5) but only include the monetary policy surprises generated from Governor speeches as the dependent variable.

Monetary policy surprises from Governor speeches could have been predicted by surprises in GDP growth, with the coefficient being positive and statistically significant at the 5 per cent level (Figure 9). The result suggests that over time Governor speeches may have revealed an increased responsiveness to GDP surprises, with upward GDP surprises leading to higher interest rates (and vice versa). Therefore, it is possible that the monetary policy surprises from Governor speeches conveyed details of the policy reaction function, as opposed to new information about the state of the economy.

However, it is slightly surprising that GDP news can explain the monetary policy surprises from Governor speeches. The relatively long time lag from the GDP release and the reference period often means that information from the release could be less relevant for monetary policy. One possible way to reconcile this is that the timing of GDP releases usually occurs the day after a Board meeting, meaning any subsequent Governor speech could be communicating information about the RBA's interpretation of that release, which was not fully evident in its communication following the Board decision.

Nonetheless, the results provide some evidence that the results found earlier in this section could potentially be explained by market participants updating their beliefs about the central bank's policy reaction function. However, it is difficult to rule out the potential for an information effect from Governor speeches without further analysis.

Footnote

Another possible explanation for the significant estimate for Governor speeches is simply a false positive. This is especially the case given the multiple hypothesis tests that are conducted. [13]