Monetary Policy and Financial Markets

Abstract

This thesis comprises three essays on monetary policy and financial markets. The research uses micro data and textual analysis to answer questions in the intersection between finance and monetary economics. Simple and intuitive models complement the empirical analysis. In the first essay, I present a large database of speeches by Federal Reserve officials that I assembled with web scraping algorithms. I parse the topic and tone of the speeches to provide empirical evidence on how Fed officials use their speeches to guide short-term interest rate expectations. Measures of misalignment between market and central bankers’ expectations predict tone in speeches about monetary policy. If markets’ near-term interest rate expectations are too high, central bankers’ speak more negatively to signal that less interest rate hikes are coming. These effects are strongest for voting Fed Presidents and Chairs of the Fed Board of Governors. I study this policy of communicating in response to market expectations in a rational expectations model, in which the central bank communicates in a discretionary fashion between interest rate decisions and is averse to bond market volatility. The second essay is co-authored with Michael Ehrmann and Bauke Visser and builds on the speech data and methods presented in the first essay. We use the Federal Open Market Committee as a setting to study how the right to vote affects behavior in a committee decision-making process, both during meetings and in between meetings. We find no evidence for a hypothesis maintaining that without the voting right, presidents use their public speeches and their meeting statements to compensate for this loss of formal influence; instead, the data support the hypothesis that with the voting right, presidents are more involved. Financial markets react less to presidents’ public speeches in years they have voting rights than in years they have not. We argue that this is consistent with our evidence on the communication behavior of presidents. The third essay provides firm-level estimates of the real effects of US monetary policy on investment in 36 countries. The key identification idea is that firms, that roll over US Dollar debt shortly after FOMC meetings, are more exposed than firms that do not. Reductions in business investment after US monetary tightening are largest in countries with pegged or managed exchange rates (non-floaters) but also significant in floaters. The stronger spillovers in non-floaters arise from firms with high leverage and are amplified by exchange rate fluctuations. A simple model of currency choice rationalizes my findings. Exchange rate management leads to higher financial vulnerability because it allows smaller and less productive firms to borrow in foreign currency, a conjecture which is confirmed in the data