Central Bank Information Under Uncertainty: How Transparent Should Central Banks Be?

Abstract

In this thesis, I examine the effectiveness of monetary policy under uncertainty. Existing literature finds that monetary policy becomes less effective during periods of high uncertainty (1) and that the informational effects of central bank announcements become more common and stronger during crises (2). Combining these findings, I examine whether monetary policy becomes less effective during high degrees of uncertainty because central bank informational effects become stronger. I first extract a monetary policy shock that captures the short-term policy of the European Central Bank (ECB) and subsequently decompose this shock into a pure policy- and information shock, which asymmetrically affect the economy. I find that when employing measures of financial uncertainty, optimistic information has a strong and positive effect on the economy as compared to periods of low uncertainty, while I find the opposite when employing measures of policy uncertainty. This finding is confirmed by several robustness tests. In periods of high uncertainty, this implies central banks should assess what type of uncertainty is characterizing the economy and adjust their policy announcements accordingly to ensure policy effectiveness. To this author’s knowledge, this is the first study to specifically examine the dynamics of information shocks under uncertainty. Keywords: Monetary Policy, Uncertainty, Local Projections, Central Bank Information, EA-MPD