bain_y_howells__monetary_economics__policy_and_its_theoretical_basis

THE MONETARY AUTHORITIES AND FINANCIAL MARKETS 371
involve paying some attention to trends in both inflation and real output the
Bank of England uses a more judgmental approach. This means that if private
sector agents are to learn about the setting of interest rates, they have
to learn alongside the Bank, or more specifically the Monetary Policy
Committee, and this requires a great deal of openness on the part of the
Bank. As we saw in Section 11.4 the Bank of England first adopted an inflation
target in 1992. Since then it has worked to create transparency by
scheduling and announcing the dates of the monthly monetary policy meetings,
issuing press releases immediately following each meeting, publishing
minutes of the meeting together with a record of the votes (since 1997) and,
most importantly perhaps, publishing the quarterly Inflation Report which
contains the information on which the decisions are based. It may be hard
work, but this should make it possible for analysts to learn over time how
interest rates are likely to move in the face of given macroeconomic trends.
Given the importance of credibility and accountability, therefore, it is not
surprising that central banks should look for evidence on their performance
and financial markets are an obvious place to look. For example, if policy
is ‘transparent’ then changes in short-term interest rates should generally be
anticipated and the prices and yields of short-dated assets should show little
response on the day of the announcement. If policy is credible, and if
the central bank is promising lower inflation (for example) in the future,
then the yield curve should slope downward , after allowing for any term
premium. Attempts to use information from financial markets in this way in
recent years are many and varied. In the case of the UK where there have
been two major changes in the monetary policy framework in the last ten
years - the adoption of inflation targeting in 1992 and the independence of
the Bank of England in 1997 — several of the studies have been of the
‘before and after’ variety.
In 1998, for example, Mervyn King (Deputy Governor of the Bank) published
a study showing the changed shape of the yield curve after the
announcement of Bank of England’s independence. Long-term yields fell
by about 40bp in response to the announcement, suggesting that the bond
market took the promises of a low inflation environment in years ahead
more seriously from an independent Bank of England than they did from its
predecessor (King, 1998). Independence, even when limited to instruments,
did indeed seem to add to credibility.
Haldane (1999) looked at changes in the shape of the yield curve in
response to changes in official rates for the period 1984 to 1997 and for the
two sub-periods 1984-1992 and 1992-1997 by calculating the average
change in yields at various maturities in response to a one per cent change