Words and deeds in managing expectations: Empirical evidence from an inflation targeting economy

Monetary policy affects private sector expectations through not only its actions, but also its communication. In this paper, we adopt a novel approach to compare the impact of central bank interest rate decisions, macroeconomic projections, and textual content of policy documents on private sector expectations. We demonstrate that the role of central bank communication and decisions differs depending on the variable and the forecast horizon. The reaction of inflation expectations to typical changes in policy communication is stronger than their responses to typical policy decisions, whereas the opposite holds for interest rate expectations. Our findings imply that central banks have a range of measures at their disposal to affect expectations. The ability to use communication in managing expectations is especially important when the scope of reducing interest rates is limited.