TAILIEUCHUNG - Central Bank Policy Rate Guidance and Financial Market Functioning∗

The paper entitled “International Convergence of Capital Measurement and Capital Requirements” 15 published by the Basel Committee on Banking Super- vision provides only general information on interest rate risk in the banking book. More specifi c information is contained in an additional paper entitled “Principles for the Management and Supervision of Interest Rate Risk” (July 2004). 16 This paper lists 15 principles that represent minimum requirements for the management of interest rate risk by credit institutions 17 and that defi ne the supervisory treatment of interest rate risk in the banking book. This paper is a revised and expanded version of the “Principles for. | Central Bank Policy Rate Guidance and Financial Market Functioning Richhild Moessnera and William R. Nelsonb aBank for International Settlements bFederal Reserve Board Several central bankers have expressed concern that providing forecasts of future policy rates may impair financial-market functioning. We look for evidence of such impairment by examining the behavior of financial markets in the United States the euro area and New Zealand in light of the communication strategies of the central banks. While we find evidence that central bank policy rate forecasts influence market prices in New Zealand we find no evidence that market participants in the three regions systematically overweight policy rate guidance or that they do not appreciate the uncertainty and conditionality of it. The results suggest that the risk of impairing market functioning is not a strong argument against central banks provision of policy rate guidance or forecasts. JEL Codes E52 E58 G14. 1. Introduction When evaluating the advantages and disadvantages of providing to the public guidance about or regular forecasts of policy rates central bankers have expressed concerns that the provision of such guidance or forecasts may impair financial-market functioning because market participants will place an inordinate amount of weight on them. We are grateful to Bill Allen David Archer Charlie Bean Meredith Beechey Claudio Borio J. Benson Durham Michael Ehrmann Luci Ellis William English Marcel Fratzscher Gabriele Galati Charles Goodhart Refet Gurkaynak Ozer Karagedikli Patricia Mosser Roberto Perli Brian Sack Philip Wooldridge Jonathan Wright Christian Upper participants at seminars at the Austrian National Bank BIS ECB and Sveriges Riksbank and two anonymous referees for helpful comments and discussions and to Garry Tang for excellent research assistance. The views expressed are those of the authors and should not be thought to represent those of the BIS or the Federal Reserve Board. 193 194 .

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