Do Financial Markets Listen when Politicians Talk About Monetary Policy?

• In Event: Exchange Rates and Government Credibility Reconsidered

Abstract

The expansion of central bank powers to include financial stability and unconventional monetary policy after the 2008 global financial crisis provoked a political backlash against central banks. Politicians have questioned the value of central bank independence and new powers and responsibilities of monetary authorities. For instance, Britain's former Secretary of State for Foreign Affairs William Hague said in 2016: “Central bankers have collectively lost the plot. They must raise interest rates or face their doom.” This paper examines the effects of political commentaries over the monetary policy of the Bank of England on the expectations of financial markets. In other words, I explore whether financial markets believe that monetary policy decisions of the Bank of England are influenced by pressures from policymakers. I assume that if financial markets believe that the central bank’s policy can be influenced by politicians, then political commentaries will affect market expectations. I develop an original database containing statements of British politicians about the monetary policy of the Bank of England between 1997, when it was given operational independence over monetary policy by the Labour government, and 2017. These are statements by politicians extracted from newspaper articles and newswire reports commenting on the Bank of England’s interest rate that are categorized as political pressures for monetary easing or tightening and on the quantitative easing. This database enables me to construct an indicator of political pressures on the Bank of England’s monetary policy. I examine a detailed pattern of the impact of political commentaries on high-frequency financial market data, including overnight index swap (a daily measure of market participants’ expected policy rate) and government bond yield spreads. I also explore whether comments by politicians on exchange rate influence the volatility of the pound-dollar exchange rate. This paper sheds new light on the question of central bank independence in the age of populism and ultra-low interest rates.

Author

• Jana Grittersova, University of California, Riverside