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Speech by Vice Chairman Fischer on monetary policy expectations and surprises

April 18, 2017 / Source: FRB

April 17, 2017

Monetary Policy Expectations and Surprises

Vice Chairman Stanley Fischer

At the Columbia University School of International and Public Affairs, New York, New York


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I will address the topic of central bank communications, with a particular emphasis on those times when financial markets and the central bank have different expectations about what a central bank decision will be. Such situations lead to surprises and often to market volatility.

Of course, not all surprises are equal. For one, communications that shift or solidify expectations that are diffuse or not strongly held are less likely to be disruptive than communications that run counter to strongly held market beliefs. Further, there are worse things than surprises. The central bank must provide its views regarding the likely evolution of monetary policy, even when this view is not shared by market participants. A concern for surprising the market should not be a constraint on following or communicating the appropriate path of monetary policy. That said, there are good reasons to avoid unintended surprises in the conduct of policy.1

Why should central banks avoid surprising financial markets? In recent decades, it has been increasingly acknowledged that monetary policy implementation relies importantly on the management of market expectations.2 In theory, clarity about the central bank's reaction function--that is, how the central bank adjusts the stance of monetary policy in response to changing economic conditions--allows the market to alter financial conditions smoothly. This typically helps meet the bank's policy targets, with the result that the markets are working in alignment with the policymaker's goals. Under this theory, repeated market surprises that raise questions about the central bank's reaction function could threaten to disrupt the relationship between the central bank and the markets, making the central bank's job more difficult in the future.3

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