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Does Central Bank Transparency Impact Financial Markets? A Cross-Country Econometric Analysis

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Introduction:
Does the degree of information a central bank release to the public have any effect on the functioning and efficiency of financial markets? Is there a significant difference between the Federal Reserve announcing policy decisions at the time of Federal Open Market Committee meetings and the Federal Reserve forcing the public to ascertain policy decisions through subsequent movements of the federal funds rate? Some authors, including Blinder et al. (2001), Poole, Rasche and Thornton (2002), and Chortareas, Stasavage and Sterne (2002), argue that transparency both helps establish monetary policy credibility in the public’s eyes and transfers clearer information to financial markets. Many prominent central banks, including the Bank of Canada, Bank of Japan, and the Bank of England, moved towards greater transparency in the 1990s, with the U.S. Federal Reserve System following suit in 1994. However, the European Central Bank (ECB) resisted implementing openness to the same degree, citing the need for speaking with a single, clear policy voice in contrast to a mix of arguments and opinions from the members of its monetary policy authority.

In fact, is it possible that central banks have perhaps become too open in their discussions with the public, and that a partial return to the days of the Fed temple is warranted? Consider the U.S. experience in the past year. Following a protracted U.S. economic slowdown and a nominal federal funds rate dropping to 1.25%, on November 21, 2002, Federal Reserve officials first suggested using long-term Treasury bond buybacks as a way to help lower long-term market interest rates. However, on July 15, 2003, in its semiannual report to the U.S. Congress, Fed chair Alan Greenspan recanted the hypothesized proposal, announcing that the action was highly unlikely. Bond markets responded emphatically, with the 10-year Treasury bond yield rising 20 basis points that day to 3.94%. Thus, public statements by the central bank moved U.S. financial markets, not because of changing economic conditions, but because of the revision of a publicly declared proposal which in turn revised agents’ future expectations. The corresponding volatility in bond markets would not have occurred under a system of reduced openness.

Are the occasional public missteps by central bankers, then, worth the increase in public information gained through transparency? Fed officials are so concerned about this issue:
See Buiter (1999) and Issing (1999) for a thorough and lively discussion of the transparency differences between the Bank of England and the ECB. that in September 2003, the FOMC for the first time held a special meeting to discuss how to communicate effectively with the public.
When the U.S. Federal Reserve System made a move towards greater transparency in the conduct of monetary policy in February 1994, it began announcing its targets for the federal funds rate on the afternoon of FOMC meetings. Previously, the Fed did not announce its policy decisions until six weeks after the meeting. This left the public to guess at the Fed’s actions, either by studying economic indicators or by watching the federal funds rate in the days and weeks following FOMC meetings, leading some economists and the media to label U.S. monetary policy “a veil of secrecy”. Gaining accurate predictions of Fed policy was so important that an entire industry of “Fed watchers” developed. After 1994, then, was there a noticeable change in the dynamics of U.S. financial markets? Did the degree of uncertainty in interest rate movements drop after 1994 in response to the additional information released by the Federal Reserve System?

Number of Pages of Project Report: 72
Package Includes: Synopsis/Project Proposal + Project Report + Excel Sheet
Project Format: Document (.doc)

Table of Contents of Project Report:
EXECUTIVE SUMMARY
CHAPTER 1: INTRODUCTION
RATIONALE OF THE STUDY
NEED OF THE STUDY
OBJECTIVES OF THE STUDY
BACKGROUND OF THE STUDY
CHAPTER 2: LITERATURE REVIEW
CHAPTER 3: RESEARCH METHODOLOGY
TYPE OF RESEARCH METHOD
DATA COLLECTION
LIMITATIONS OF THE STUDY
DATA DESCRIPTION AND SOURCES
MODEL AND HYPOTHESIS
CHAPTER 4: DATA ANALYSIS
EMPIRICAL MODEL
FINDINGS & RECOMMENDATIONS
CONCLUSION
REFERENCES


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