Monetary Policy Surprises and Expectations

Abstract:

Central Bank policy decisions affect the economy not only through the direct effects of the bank’s market interventions on market conditions, but also through the eff.ects that the announcement of the decisions may have on people’s forecasts of economic conditions. This paper, using Brazilian Survey data that reports daily statistics, studies how forecasts of inflation and output growth respond to unexpected policy rate decisions. The results show that inflation forecasts increase in the short run after an unexpected increase in the policy rate and show a mild decrease 1 year after the meeting. Output forecasts, when measured by industrial production growth also increase in the short run, but less strongly than inflation. When measured by the growth in gross domestic product, show no response. The theoretical section develops a New Keynesian model with a signaling role of the interest rate. The empirical results can be explained when firms possess less information than the central bank at the time they see the interest rate and they interpret «enough» of the surprise in the rate as information about the current natural rate of interest.