Jeremy M. Piger

English

Research Papers in Economics

August 2006 MonetaryTrends
Views expressed do not necessarily reflect official positions of the Federal Reserve System.
A
nnouncements by the Federal Reserve regarding
its target value for the federal funds rate garner
substantial attention from the media and partici-
pants in financial markets. Indeed, there is evidence that
the “news” in these announcements, or the deviation of the
targeted funds rate from market expectations, affects the
price of assets traded in various financial markets, most
notably those for equities and bonds.
In recent years, however, communication from the
Federal Reserve has increasingly included not just policy
decisions on where to set the federal funds rate, but also
many forms of non-quantitative communication: that is,
the written statement released following meetings of the
Federal Open Market Committee; testimony by Federal
Reserve officials, particularly the Chairman, before
Congress; and speeches made by Federal Reserve gov-
ernors and regional Reserve Bank presidents. I discuss
here some evidence regarding whether this large amount
of written and verbal communication is also deemed impor-
tant by market participants for valuing financial assets.
This would be the case if buyers and sellers believed that
Federal Reserve talk was informative about the direction
of future policy, conveying information that should influ-
ence market expectations. In addition, market participants
may value Federal Reserve talk if they believe it conveys
some new information about the state of the economy.
A difficulty in evaluating the market effects of Federal
Reserve talk is obtaining a quantitative measure of the
content of qualitative communication. One approach is to
construct such a measure through a subjective reading of
the text. However, this approach may be contaminated by
the biases of the researcher and is cumbersome when there
is a large amount of text to analyze. In a recent study,
Michelle Bligh and Gregory Hess of The Claremont
Colleges take a different approach based on “content
analysis.” Content analysis assesses the prevalence of
words in a text that match those in predetermined word
lists created by linguists. For example, lists that contain
words that express “optimism” or “pessimism” can be used
to characterize the optimistic or pessimistic tone of any
piece of text.
Using this approach, Bligh and Hess study the effects
of a variety of written and verbal communications by Alan
Greenspan, the former Federal Reserve Chairman, over the
period 1999-2004. They find that the language used by
Chairman Greenspan had significant predictive power for a
number of financial variables. In particular, this language
was a significant predictor of equity prices as well as short-
and long-term interest rates in the days immediately follow-
ing the communication, with the most sustained effects
occurring in Treasury bond yields. Interestingly, all the
forms of non-quantitative communication they analyzed,
including statements, testimony, and speeches, had some
amount of predictive power.
The fact that Federal Reserve talk influences the behavior
of financial markets has at least two important and related
implications. The first is that written and verbal communi-
cation by Chairman Greenspan was taken seriously by the
markets over this period. This is no small achievement given
that such communication is by its very nature unverifiable
and open to interpretation. Second, it suggests that written
and verbal communication is an effective tool that the
Federal Reserve has at its disposal to convey information
to financial markets. The extent of non-quantitative commu-
nication and the language used in these communications
are likely to be important choices made by Federal Reserve
policymakers in the future. Indeed, there is already a widely
held perception that the language used in the policy state-
ment released following FOMC meetings under Chairman
Ben Bernanke has differed from that used under Chairman
Greenspan.
—Jeremy M. Piger
Bligh, Michelle and Hess, Gregory D. “A Quantitative Assessment of the
Qualitative Aspects of Chairman Greenspan’s Communications.” Unpublished
manuscript, Claremont McKenna College, 2005.
Is All That Talk Just Noise?
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Is all that talk just noise?

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Is all that talk just noise?

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