Does the beige book move financial markets?

• Author: Zavodny, Madeline

1. Introduction

   A number of studies indicate that macroeconomic data releases cause movement in a number of financial instruments, including interest rates, stocks prices, and exchange rates (Andersen et al. 2003; Flannery and Protopapadakis 2002; McQueen and Roley 1993). Financial markets also respond to changes in monetary policy via the federal funds rate target (Balduzzi, Bertola, and Foresi 1997). However, little is known about how, or even whether, financial markets systematically respond to qualitative, or nonnumerical, information, such as speeches by Federal Reserve and government officials and nonquantitative economic reports.

   Casual empiricism on the part of members of the media leads them to frequently attribute changes in financial markets to qualitative information released by the Federal Reserve. One such qualitative report is the Beige Book, which is a description of economic activity compiled by the 12 regional Federal Reserve banks and released about two weeks before each meeting of the Federal Open Market Committee (FOMC). The media often reports that markets moved in response to the information contained in the Beige Book, with headlines such as "Russell 2000 Retreats After Release of Beige Book" and "Bond Prices Are Lifted by the Fed's Beige Book." (1) This paper examines whether the Beige Book indeed affects stock prices and interest rates.

   There are several reasons why the release of the Beige Book might influence financial markets. First, several studies show that the Beige Book is a good indicator of economic activity. Balke and Petersen (2002) conclude that the Beige Book is a significant predictor of both current and next-quarter real gross domestic product (GDP), even above and beyond other contemporaneous indicators such as the Blue Chip Consensus Forecast and lags of the growth rates of real GDP, industrial production, and employment. (2) Payne (2001) similarly finds that the Beige Book is well correlated with a variety of economic indicators, including the change in indexes of coincident and leading indicators, the unemployment rate, and capacity utilization. (3) Given the long lags in the release of some data series, the Beige Book may reflect information not yet available via other sources and thereby affect financial markets.

   Even if the report does not contain any new information, financial markets might view the Beige Book as a useful summary of economic activity leading into FOMC meetings. Unlike other data series, the timing of the information gathering and the release date are explicitly geared to the FOMC meetings, which occur eight times a year. Comments from Federal Reserve officials indicate that they rely in part on the Beige Book for such reasons when making policy decisions. For example, FOMC chairman Alan Greenspan reportedly likes the anecdotal information contained in the Beige Book because it provides firsthand insights into the economy in advance of the FOMC meetings (McTague 1991).

   In addition, the Beige Book might affect financial markets if the report signals the likely direction of monetary policy. A strong Beige Book report might indicate that the FOMC is likely to tighten monetary policy at its next meeting, while a weak Beige Book might suggest that the FOMC will ease monetary policy. Because the research staffs that advise monetary policy makers have input into the report, the Beige Book may reflect their perceptions and preferred course of policy. Payne (2001) finds that the Beige Book is a significant predictor of changes in the federal funds rate target, outperforming the output gap in a Taylor rule model.

   Examining the effect of the Beige Book on financial markets allows us to evaluate whether qualitative information on economic activity affects financial markets in the same way as releases of quantitative macroeconomic data. Although many researchers have examined the impact of data releases, few have examined the effect of qualitative reports because such studies face several hurdles. In studies of data releases, the "news" is relatively easy to determine because the data are released on a regular schedule and at a particular time of day. Researchers typically examine the surprise component of such data releases by taking the difference between the announced value and the average of expected values. In contrast, "headline news," such as speeches about the economy by Greenspan, happens at irregular intervals and may prove difficult to identify and quantify. In addition, expectations about such reports are, at best, difficult to ascertain.

   A few previous studies have examined the effect of qualitative reports on financial markets. Most notably, Kohn and Sack (2003) examine the effect of FOMC statements and Congressional testimony and major speeches by Greenspan, focusing on whether financial instruments were more volatile on event days, not on whether and how the actual content of such statements affected asset prices. Kohn and Sack find that FOMC statements and Congressional testimony by Greenspan increase the volatility of financial instruments, but major speeches by Greenspan do not. Other studies suggest that the quantity of financial news reported by the media is correlated with stock market returns and trading volume (Berry and Howe 1994; Mitchell and Mulherin 1994). We are not aware of any previous research that links the actual content of qualitative news to changes in financial markets.

   The next section briefly describes the Beige Book and offers economic intuition for why the report might influence financial instruments. We then explain the quantitative index of the Beige Book that we created in order to investigate whether the reports are associated with changes in several measures of interest rates and equity prices during the period mid-1983 to 2001. The results indicate that the qualitative information contained in the Beige Book is associated with changes in some financial markets, mainly intermediate- and long-term interest rates. Controlling for available data on GDP growth or industrial production suggests that markets view the Beige Book as a summary indicator of recent economic growth.

2. Description of the Beige Book

   The Beige Book is a survey of regional economic conditions publicly released about two weeks prior to each FOMC meeting since mid-1983. (4) Each of the 12 regional banks writes a summary of economic conditions in its district, and one bank (on a rotating basis) writes a summary of national economic conditions based on the 12 regional reports. The research staff at the Board of Governors does not write the regional reports or the national summary but does have input into the wording of the document, particularly the national summary.

   Each Federal Reserve Bank uses its own information-gathering methods to compile its Beige Book report. Most districts use a variety of methods, including calling local businesses, conducting regular surveys, reading local newspapers, and having members of their Boards of Directors report on current and expected future economic conditions. The regional banks tend to emphasize those sectors that are economically important in the various districts, as well as recent major economic developments. The reports focus on economic conditions since the last FOMC meeting, essentially the last four to six weeks. Although the reports sometimes include details about future expectations, the Beige Book primarily discusses contemporaneous conditions and recent events.

   Quantifying the Beige Book

   In order to examine the effect of the content of the Beige Book on financial markets, the qualitative reports need to be quantified. Because the Beige Book is anecdotal, the reports describe the pace of economic activity with adjectives such as strong, moderate, or weak. Following the method of Balke and Petersen (2002), we created a quantitative index of these qualitative descriptions. We recreated Balke and Petersen's index in order to evaluate whether it is possible to derive consistent quantitative measures of the qualitative accounts in the Beige Book, as well as to update it. We read each Beige Book (without knowing the release date) released between May 1983 and December 2001 and scored the description of economic growth in the national summary on a scale from -2 to 2, with lower scores indicating weaker growth. A Beige Book describing modest growth typically was scored 0.5; a Beige Book describing strong growth received a score of 1 to 1.5; a Beige Book that indicated that activity was contracting received a negative score. Although key adjectives were helpful in determining the Beige Book score, we did not solely rely upon them. Instead, we used our judgment in much the same way financial market participants would. This analysis uses the average of our two scores for the national summary. (5) The strong correlation between our scores and Balke and Petersen's scores (p = 0.94) during the period they overlap (1983-1996) suggests that such indexes can be replicated fairly reliably.

   Our Beige Book index is well correlated with the pace of economic activity. As Figure 1 indicates, the index tends to be high during times of strong GDP growth and negative during recessions (the shaded areas). The raw correlation between our Beige Book index and real currentquarter GDP growth is 0.672. To further investigate whether our index is well correlated with output growth, we regressed real GDP growth rates on the index using Balke and Petersen's (2002) methodology. Table 1 reports the results for our index and for Balke and Petersen's index. Our index is as well correlated with GDP growth through 1996, as is Balke and Petersen's index (columns 1 and 2). Including the 1997-2001 period slightly reduces the goodness of fit of our index as measured by the adjusted [R.sup.2], but the relationship remains positive and statistically significant (column 3).

   [FIGURE 1 OMITTED]

   The Beige Book index also appears to...