Text Shocks and Monetary Surprises

Abstract

This dissertation consists of two chapters investigating how the words of the Federal Open Market Committee (FOMC) impact investor expectations of monetary policy, how variation in the FOMC’s words can be used to capture unexpected changes in monetary policy, and the macroeconomic effects of monetary policy. In the first chapter, I provide quantitative evidence that changing the wording of post-FOMC-meeting statements shifts market expectations of future monetary policy. I produce a pairwise-statement similarity measure that compares word-use between two FOMC statements. This similarity measure shows that FOMC statements have become more similar over time. With an event-study approach, I find that a decrease in the similarity of sequential FOMC statements is correlated with an increase the variation of federal funds rate expectations, calculated from high-frequency fed funds futures (FFF) prices. Adding the sequential statement similarity measure to a regression of federal funds rate expectations on the target rate accounts for 1.5 times the variation in market expectations. Furthermore, by interacting the similarity measure with the Federal Reserve Chair, I find that market expectations responded the most to language under Bernanke and Yellen, but not under Greenspan. In the second chapter, I adapt neural network methods for text analysis from the computer science literature to analyze how the wording in FOMC statements jointly impacts FFF prices when these statements are announced. Analyzing differences between FOMC statements and internal meeting materials, I create a new monetary policy “text shock” series for 2005-2014 that isolates the variation of FFF prices induced by the FOMC’s policy - target rate, forward guidance, and quantitative easing - not their current assessment of the economy. I find that the wording of FOMC statements accounts for four times more variation in FFF prices than direct announcements of changes in the target federal funds rate. I also find that the impact of forward guidance on real interest rates is twice as large when using text shocks over other measures, like changes in FFF prices. Furthermore, the text shock produces responses in output and inflation qualitatively consistent with workhorse macroeconomic models, whereas changes in FFF prices do not.