Disagreement about Monetary Policy

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Monetary policy is subject to debate. Market participants and forecasters disagree about future inflation and interest rates. However, there is also disagreement among policy-makers themselves about the future course of policy, which should affect the perception of policy by market participants. This project focuses on the latter type of disagreement among policy-makers in the euro area. Disagreement should be particularly important against the backdrop of unconventional monetary policy such as forward guidance, which relies on the ability of the central bank to provide information about future policy. If disagreement obfuscates the interpretation of signals from the central bank, policy might be less powerful.We study disagreement of policy-makers in the Governing Council of the European Central bank (ECB). In contrast to other central banks, the decision-making process at the ECB remains opaque. We overcome this problem by measuring disagreement based on text data, i.e. speeches delivered by policy-makers and transcripts of the regular press conferences. We plan to address disagreement in three steps: First, we use information from the press conference to construct a narrative index of dissent. We will assess whether the market reaction on meeting days is different depending on dissent or unanimity in the meeting. We will also evaluate whether dissent in the meeting affects the dispersion of views of the private sector. Second, we will extend our existing database to include all speeches of members of the ECB’s Governing Council. Based on a computational linguistic model, we slice the corpus of speeches into distinct topics, such that we can construct a topic-specific measure of disagreement. In a time-series model we evaluate the consequences of disagreement for policy transmission. Third, we study different preferences about inflation and real economic activity as one important source of disagreement among members of the council. In theoretical models of optimal monetary policy, preferences are expressed by a loss function, which the central bank minimizes based on a model of the economy. In contrast to the literature, we estimate loss functions directly, both for the council and for individual members, based on the tone of speeches rather than the solution of a full model of the economy. This also allows us to evaluate non-quadratic loss functions, where policy-makers put different weights on positive and negative deviations of inflation or unemployment from target. All three parts of the project will provide new insights into the relationship between monetary policy and financial markets and the transmission of monetary policy impulses.