Working Paper Series no. 779: Fed Communication on Financial Stability Concerns and Monetary Policy Decisions: Revelations from Speeches

The aim of this paper is to assess if speeches given by Federal Open Market Committee (FOMC) members reveal information about their financial stability concerns and whether these concerns systematically relate to the Federal Reserve’s monetary policy decisions. The advantage of analyzing public speeches is that they are a flexible and less standardized form of communication, and, to some extent, reflect debates and opinions that have been expressed in FOMC meetings and, therefore, have guided policy (Bernanke, 2015).

To extract information from speeches we use textual analysis techniques (refined with human knowledge) to compute two speech-based indicators. First, we classify each speech into different economic and finance-related topics and calculate what we subsequently label topic proportion: the share of a speech dedicated to a specific topic. Second, we calculate a sentiment indicator, representing the negative tone expressed toward a topic. Our speech data set consists of publicly accessible speeches given by the Chair of the Federal Reserve, the members of the Federal Reserve Board of Governors (Governors) and the presidents of the 12 Federal Reserve Banks (FRB presidents), which comprise the FOMC.

We look at three dimensions of the financial stability topic: i) Financial Stability (FS), relating to communication about excessive risk-taking behaviour or vulnerabilities in financial markets, ii) Financial Conditions (FC), referring to communication about financial and banking developments (here we also consider Housing as a related but separate topic) and iii) Supervision and Regulation (SR), relating to communication about the supervisory and regulatory efforts taken by the central bank, alone or in cooperation with other agencies, to mitigate the risks and consequences of financial instabilities. In this respect, we provide a broad, multidimensional picture of how financial stability considerations are communicated and dealt with by the Federal Reserve. We refer to these three topics (including Housing) as the finance-related topics.

Looking at the period from 1997 to 2018, we document that FRB presidents spoke more than Governors around and after the financial crisis, and exhibit more variation in the topics of their speeches. FRB presidents speak predominantly about the Economy and the Monetary Policy topics. Only during the crisis, they increased their speaking time on the financial stability topic. In contrast, Governors have high and stable proportions in finance-related topics. These differences likely reflect the institutional design and different responsibilities of FRB presidents versus Governors.

When added to a standard forward-looking Taylor rule for the pre-financial crisis period, our speech-based indicators of finance-related topics show that a higher speech intensity on these topics relates to a more accommodative monetary policy. We find an exception from the communication on Housing, for which a higher speaking time on this topic is associated with a tighter monetary policy. We further assess whether the institutional role of the speaker matters and find that our results are entirely driven by the speeches of FRB presidents. Even though FRB presidents are often criticised of cacophony by the financial press and market participants, we find that there is news in their public remarks.

Overall, these results suggest that an institutionalized and frequent communication that conveys the FOMC’s assessments of financial vulnerabilities and their potential implications for monetary policy could be beneficial to make the policy reaction function of the Federal Reserve more transparent.