Monetary Policy Uncertainty and Monetary Policy Surprises

Abstract

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.

Central Banks in Parliaments: A Text Analysis of the Parliamentary Hearings of the Bank of England, the European Central Bank and the Federal Reserve

“…The peak for the Brexit referendum is documented in the updated index provided by the authors at this link: https://www.policyuncertainty.com/uk_monthly.html.22 There is extensive evidence on how uncertainty has a negative impact on monetary policy (see, for example,Husted et al, 2019;Tillmann, 2019;Bauer et al, 2019De Pooter et al, 2020 ECB Working Paper Series No 2442 / July 2020…”

The Term Structure of Monetary Policy Uncertainty

“…We choose the 1-quarter and the 5-quarter contracts because they are, respectively, the shortest and longest horizons over which Eurodollar options reliably trade over our sample. We also elect to include changes in the 4-quarter ahead Eurodollar options contracts as this 1-year ahead horizon has been the focus of much of the recent empirical literature on monetary policy uncertainty (Husted, Rogers and Sun, 2019;De Pooter et al, 2021;Bauer, Lakdawala and Mueller, 2021). 7 Our approach is conservative in the sense that if more than one factor is needed to explain changes across these three maturities of interest-rate options contracts, then one factor would similarly be insufficient to explain FOMC-induced shifts across a wider range of interest-rate options contracts.…”

“…This literature dates back to Kuttner (2001) More recent work has extended these event study regressions to show a link between the effect of monetary policy announcements on longer-term interest rates and the prevailing level of interest rate uncertainty just ahead of the announcement. De Pooter et al (2021) show that high (low) levels of monetary policy uncertainty dampen (amplify) the response of longer-term Treasury yields to surprise monetary policy announcements. Bauer, Lakdawala and Mueller (2021) present similar evidence across a broader range of assets.…”

“…There is no agreed upon measure of the first-moment monetary policy surprise. Therefore, to ensure that the most robust empirical evidence surfaces, we examine the three most commonly used measures of monetary policy surprises in the monetary policy event-study literature: the change in the nominal 2-year zero coupon Treasury yield (Hanson and Stein, 2015;De Pooter et al, 2021), the target & path factors (Gurkaynak, Sack and Swanson, 2005), and the pol-13 icy news surprise (Nakamura and Steinsson, 2018;Bauer, Lakdawala and Mueller, 2021).…”

“…In contrast to the evidence from the existing monetary policy uncertainty literature, the explanatory power of our interest rate uncertainty factors in driving Treasury yields is not derived from the way in which they shape the transmission of first-moment monetary policy surprises. For example, De Pooter et al (2021) and Bauer, Lakdawala and Mueller (2021) present evidence of a negative and statistically significant interaction term between the level of interest rate uncertainty ahead of the FOMC announcement and the first-moment monetary policy surprise in regressions of changes in Treasury yields around FOMC meetings.…”