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Forecasting the direction of policy rate changes : the importance of ECB words

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  • ROSA, Carlo

    (Université catholique de Louvain (UCL). Center for Operations Research and Econometrics (CORE))

Abstract
This paper evaluates the predictive power of different information sets for the European Central Bank (ECB) interest‐rate‐setting behaviour. We employ an ordered probit model, i.e. a limited dependent variable framework, to take into account the discreteness displayed by policy rate changes. The results show that the forecasting ability of standard Taylor‐type variables, such as inflation and output gap, is fairly low both in‐sample and out‐of‐sample, and is comparable to the performance of the random walk model. Instead by using broader information sets that include measures of core inflation, exchange rates, monetary aggregates and financial conditions, the accuracy of the forecasts about ECB future actions substantially improves. Moreover, ECB rhetoric considerably contributes to a better understanding of its policy reaction function. Finally, we find that that the ECB has been fairly successful in educating the public to anticipate the overall future direction of its monetary policy, but has been less successful in signalling the exact timing of rate changes.
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Suggested Citation

  • ROSA, Carlo, 2009. "Forecasting the direction of policy rate changes : the importance of ECB words," LIDAM Discussion Papers CORE 2009001, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  • Handle: RePEc:cor:louvco:2009001
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    2. Bennani, Hamza, 2014. "The art of central banks' forward guidance at the zero lower bound," MPRA Paper 57043, University Library of Munich, Germany.
    3. Cour-Thimann, Philippine & Jung, Alexander, 2021. "Interest-rate setting and communication at the ECB in its first twenty years," European Journal of Political Economy, Elsevier, vol. 70(C).
    4. Sarah Brown & Mark N. Harris & Christopher Spencer, 2020. "Modelling Category Inflation with Multiple Inflation Processes: Estimation, Specification and Testing," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 82(6), pages 1342-1361, December.
    5. Freddy H. CASTRO, 2012. "Senales de política monetaria y movimientos en la estructura a plazo de la tasa de interés en Colombia," Archivos de Economía 9908, Departamento Nacional de Planeación.
    6. Cour-Thimann, Philippine & Jung, Alexander, 2020. "Interest rate setting and communication at the ECB," Working Paper Series 2443, European Central Bank.
    7. Bennani, Hamza, 2014. "Does one word fit all? The asymmetric effects of central banks' communication policy," MPRA Paper 57150, University Library of Munich, Germany.

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