Macroeconomic news, monetary policy and the role of financial markets

This project addresses the effect of macroeconomic news, such as announcements about monetary policy, on asset prices, as well as the reverse causation, namely how shocks in asset prices influence monetary policy. We expect there to be substantial interde pendence between monetary policy and asset prices in general, each reacting to new information in the other. However, although some research has been devoted to study the role of monetary policy for asset price developments, or vice versa, very little wor k has been conducted trying to investigate the joint interdependence between these variables. This is crucial information to ensure an efficient monetary policy implementation. The first objective will be to quantify empirically daily responses in asset prices to various macroeconomic announcements. This involves monitoring both the contents of the macroeconomic news and market expectation to each announcement. The analysis is applied to Norway, Sweden and New Zealand, as the Central Banks in these coun tries publish their interest rate forecast, making them the most transparent central banks in the world. This makes it feasible to separate the surprise element in the monetary policy announcements, from the forecasted expected interest rate path. The se cond objective will be to use this information in a system to model the two way interaction between monetary policy and asset price fluctuations in a series of open economies. This involves the issue of identification of shocks. We provide a new way to ju stify the identification by arguing that the link between surprise monetary policy actions and initial asset price responses identified in the first part of this project could be a feature that structural models should replicate on impact. At the Univer sity of Berkeley Professors Christina Romer and David H. Romer are leading in this field. Cooperation with these capacities will therefore strengthen the project above what can be obtained in Norway.