bain_y_howells__monetary_economics__policy_and_its_theoretical_basis

turn. On the other hand, the widening of these specific spreads will not be
irrelevant to the broader picture if the firms concerned had previously been
responsible for a large fraction of aggregate investment which they are
forced to abandon by the sharp increase in the cost of capital.
Exercise 12.3:
The most recent efforts to extract information about macroeconomic
trends from financial market data involves profit warnings. In the UK
London Stock Exchange and the Financial Services Authority require firms
to disclose to the Company Announcements Office without delay any
change in the company’s condition which might lead to substantial movement
in the price of its listed securities. Recent work at the Bank has examined
the response of returns on a company’s securities to trading statements
in general and to negative trading statements (‘profits warnings’) in particular.
Two notable results, though not especially relevant to policy, are that
returns begin their response to the warnings up to two days before they are
made and the adjustment is complete on the day of the announcement (lending
support to the semi-strong version of the efficient market hypothesis)
and that the response to negative statements is much stronger than the
response to positive statements. More relevant to the question of whether
company news can provide useful leading information about the state of the
macroeconomy is the correlation between the number of profit warnings per
month and subsequent GDP growth. Preliminary results suggests that it may
be (Clare, 2001).
12.5 Markets as a test of credibility
THE MONETARY AUTHORITIES AND FINANCIAL MARKETS 369
Suppose that the differential between ‘AAA’ corporate bond yields and yields on
government bonds have normally averaged about 75bp. In the last two quarters you
have observed this spread fall to about 40bp. About 20 per cent of the corporate
bond market (by value) consists of bonds issued by firms in the media and communications
industries and shares in these firms have increased sharply in value over
the last year. What useful information, if any, might you be able to draw from the
change in bond spreads? Explain any difficulties you may have in drawing conclusions.
In Section 8.4, we explored the Kydland and Prescott argument that elected
governments would always be faced with the problem of time inconsistency
in their formulation of appropriate monetary policy. Knowing this, private
sector agents are unlikely to believe governments whose stated aims
are to reduce high rates or maintain low rates of inflation. This lack of cred-