The Impact of Central Bank Communication on Financial Markets: the case of the Peoples Bank of China

Abstract

Central bank communication can be defined as the provision of information by the central bank to the public regarding such matters as the objectives of monetary policy, the monetary policy strategy, the economic outlook, and the outlook for future policy decisions. (Blinder et al., 2008) Although such a practice used to be considered as obnoxious by central bankers, a fundamental shift has taken place since 1990s with central banks coming out of mystery and becoming more open and transparent. The underlying theories suggest that communication can help central banks to steer the financial markets by managing market expectations, and in turn influence the real economy. Due to the difficulty involved in examining central bank communication effectiveness by capturing its impact on inflation, output and employment, most of the literature takes a more direct and econometrically feasible approach to measure the correlation between central bank communication events and the moves of financial market returns and volatility. A growing number of studies have been done on advanced central banks, whereas the research on the Chinese central bank – the Peoples Bank of China (PBoC) – is still at its primary stage. This dissertation attempts to measure the impact of PBoC communication on financial markets, as a forthright approach to examine the effectiveness of central bank communication in China, and then draw some pertinent implications.

After a review of theories of central bank communication and its connection with financial markets, I conduct an empirical research employing an EGARCH model to capture both the price effect and the volatility effect of central bank communication on Chinese financial markets. Daily data of asset returns in money markets, bond markets, stock markets and foreign exchange markets from October 2006 to September 2015 are used. A comparison of three sub periods is done as well, to reflect the variant results before, during and after the 2008 global financial crisis. Moreover, in order to understand communications importance relative to monetary policy instruments for the PBoC, I also compare its impact on financial markets with that of the benchmark lending and deposit rate changes, the reserve requirement ratio adjustments and the open market operations etc.

The results show that throughout the sample period PBoC communication generally moves the interest rates as well as the stock market returns toward its desired direction and also influences financial market volatilities in a statistically significant way, and that PBoC communication has been playing an increasingly important role in efficiently managing market expectations and promoting monetary policy effectiveness after the 2008 global financial crisis, both in absolute terms and in relative terms - compared with the effectiveness of monetary policy instruments.