Do monetary policy transparency and central bank communication reduce interest rate disagreement?

• Author: Pornanong Budsaratragoon,Ruttachai Seelajaroen,Boonlert Jitmaneeroj
• DOI: http://doi.org/10.1002/for.2631
• Published date: 01 April 2020
• Date: 01 April 2020

RESEARCH ARTICLE

Do monetary policy transparency and central bank

communication reduce interest rate disagreement?

Ruttachai Seelajaroen

1

| Pornanong Budsaratragoon

1

| Boonlert Jitmaneeroj

2

1

Chulalongkorn Business School,

Chulalongkorn University, Bangkok,

Thailand

2

School of Business, University of the

Thai Chamber of Commerce, Bangkok,

Thailand

Correspondence

Boonlert Jitmaneeroj, School of Business,

University of the Thai Chamber of

Commerce. Bangkok 10400, Thailand.

Email: boonlert_jit@utcc.ac.th

Abstract

Yes. This study produces evidence that monetary policy transparency and com-

munication policy of the Bank of England have information content in reduc-

ing disagreement about interest rate forecasts. Different from most extant

studies employing the transparency index derived from official documents of

the central banks, this study extends the literature by using a recently devel-

oped market‐based monetary transparency index. Moreover, this study ana-

lyzes forecast disagreement in a multivariate perspective based on survey

data of short‐and long‐term rates over short and long horizons. This study

characterizes several patterns on forecast disagreement related to maturities

of interest rates, forecast horizons, recessions, forward guidance, credibility,

transparency, and communication policy. Interestingly, disagreement among

the Monetary Policy Committee in policy rate decisions is associated with

lower disagreement among professional forecasters on interest rate outlook,

whereas neither announcement of changes in policy rates nor publication of

inflation reports affects forecast disagreement. These results have important

implications for monetary policymakers in managing market expectations of

interest rates.

KEYWORDS

central bank communication, disagreement, monetary policy, monetary policy committee,

transparency

1|INTRODUCTION

There is a growing concern among academics and practi-

tioners that monetary policy works mainly through man-

aging market expectations (e.g., Blinder, Ehrmann,

Fratzscher, Haan, & Jansen, 2008; de Mendonca &

Galveas, 2013; Ehrmann, Eijffinger, & Fratzscher, 2012;

Jitmaneeroj, Lamla, & Wood, 2019; van der Cruijsen,

Eijffinger, & Hoogduin, 2010). As Woodford (2001) states:

“If the beliefs of market participants are diffuse and

poorly informed, this is difficult, and monetary policy will

necessarily be a fairly blunt instrument of stabilization

policy ….”In this respect, most central banks have

improved monetary policy transparency, as a high degree

of transparency of policy decisions should result in a

common understanding among central bank watchers,

which in turn brings with it reductions in forecast dis-

agreement (e.g., Ehrmann & Fratzscher, 2009; Montes,

Oliveira, Curi, & Nicolay, 2016; Neuenkirch, 2012;

Swanson, 2006; Trabelsi, 2016). Forecast disagreement

about the state of the economy has important implica-

tions for the conduct of monetary policy. Large disagree-

ment provides a signal to central banks regarding the

level of uncertainty perceived by market participants

(Ehrmann et al., 2012). More often than not, the litera-

ture has extensively focused on the influence of

Received: 1 January 2019 Revised: 28 June 2019 Accepted: 28 October 2019

DOI: 10.1002/for.2631

368 © 2019 John Wiley & Sons, Ltd. Journal of Forecasting. 2020;39:368–393.wileyonlinelibrary.com/journal/for

transparency on disagreement about inflation expecta-

tions (e.g., de Mendonca & Filho, 2017; Glas &

Hartmann, 2016; Montes et al., 2016; Siklos, 2013;

Trabelsi, 2016). Unlike this strand of literature, the cur-

rent study contributes to the limited studies on the effect

of transparency and communication policy of the Bank of

England (BOE) on disagreement about interest rate fore-

casts in the following aspects.

First, the precise measures of monetary policy trans-

parency depend on several attributes that are not directly

observable. The most commonly used transparency index

is constructed from the official document and informa-

tion disclosure by central banks to the public (e.g., Dincer

& Eichengreen, 2014; Eijffinger & Geraats, 2006; Siklos,

2011). This type of transparency index tends to be affected

by a subjective judgment of researchers in assigning the

transparency scores. Moreover, it is usually available at

the annual frequency since institutional characteristics

of central banks rarely change in short periods

(de Mendonca & Galveas, 2013; Kia, 2017; Montes et al.,

2016). For these reasons, Kia (2011) argued that what

was important for monetary policy transparency was

how market participants understood the implementation

of monetary policy, rather than what policymakers

intended to convey to the market. Given the limitations

of such a document‐based transparency index, our study

is believed to be the first attempt to apply Kia's (2011)

methodology to construct the market‐based transparency

index, which reflects market perceptions of the BOE

monetary policy actions.

Second, the BOE has moved toward greater transpar-

ency of policy decisions by engaging in several elements

of communication policy that enable market participants

to obtain thorough information about the monetary pol-

icy and to understand factors on which the BOE bases

its formulation of monetary policy (Chortareas,

Jitmaneeroj, & Wood, 2012; Ehrmann & Fratzscher,

2009). In turn, this should allow central bank watchers

to better anticipate the future course of interest rates. To

this end, this study examines which element of monetary

policy communication (i.e., the publication of inflation

reports, disagreement among the Monetary Policy

Commission (MPC) in policy rate decisions, and the

announcement of changes in policy rates) is effective in

achieving the objective of reducing disagreement about

interest rate forecasts.

Third, extant studies on the association between mon-

etary policy transparency and disagreement about inter-

est rate forecasts have focused almost exclusively on

short‐term interest rates (Howells & Mariscal, 2007;

Swanson, 2006). Nevertheless, the effect of monetary pol-

icy is not always described by its direct effect on short‐

term rates, but rather long‐term rates which play a crucial

role as a primary transmission channel of monetary pol-

icy to real economy activity (Herrmann & Schroeder,

2008; Papadamou, 2013). To stimulate economic activi-

ties, central banks should be able to influence a whole

spectrum of interest rates and market expectations for

interest rates (Blinder et al., 2008). Besides, while the

short‐horizon predictability is likely to be relevant to

financial markets since unanticipated policy decisions

typically cause a repositioning of market participants,

the long‐horizon predictability can be more pertinent to

the real economy since investment decisions consider

the entire future course of interest rates over investment

horizons (Ehrmann & Fratzscher, 2009). To address these

issues, this study broadens the analysis by accounting for

the likelihood that the extent of disagreement may differ

depending on maturities and horizons of interest rate

forecasts. In doing so, disagreement is analyzed for four

cases: SMSH (short maturity–short horizon), SMLH

(short maturity–long horizon), LMSH (long maturity–

short horizon), and LMLH (long maturity–long horizon).

Finally, recent studies show that analyzing forecast

disagreement in a multivariate perspective is more suit-

able than treating forecast disagreement about each vari-

able separately (e.g., Banternghansa & McCracken, 2009;

Dovern, 2015; Drager & Lamla, 2017). In this sense, the

current study not only examines disagreement in the con-

text of interest rate expectations for each case of SMSH,

SMLH, LMSH, and LMLH but also investigates these

cases simultaneously in a panel data framework. Profes-

sional forecasters who believed in the expectations

hypothesis of the term structure of interest rates would

likely adjust their forecasts of short‐and long‐term rates

over short‐and long‐horizons as their information set

has changed over time (Blinder et al., 2008; Jitmaneeroj

& Wood, 2013). In addition, this study considers that dis-

agreement on interest rate forecasts tends to be driven by

disagreement about gross domestic product (GDP),

inflation, and unemployment forecasts (Carlstrom &

Jacobson, 2015; Drager & Lamla, 2017; Jitmaneeroj

et al., 2019; Swanson, 2006). The logic for doing so is

based on the possibility that professional forecasters con-

struct their interest rate expectations in a congruent man-

ner that jointly describes their views of the term structure

of interest rates and the states of the economy.

The results of this study reveal a number of important

patterns on disagreement about interest rate forecasts

related to maturities of interest rates, forecast horizons,

recessions, forward guidance, credibility, transparency,

and elements of central bank communication. Increased

transparency and central bank communication indeed

serve as a coordination tool among market participants,

and hence reduce forecast disagreement about interest

rate outlook. Most importantly, disagreement among

SEELAJAROEN ET AL.369