Unsurprising shocks: information, premia, and the monetary transmission

Central banks’ decisions are a function of forecasts of macroeconomic fundamentals. Because private sector forecasts are not bound to be equal to central banks’ forecasts, what markets label as unexpected may or may not be unanticipated by the central bank. Monetary surprises can thus incorporate anticipatory effects if market participants fail to correctly account for the systematic component of policy when they are surprised by an interest rate decision. Depending on how market participants perceive the policy decision, their economic projections and the associated risk compensations move in opposite directions, and do so at the time of the announcement. Hence, and regardless of the width of the measurement window, monetary surprises capture more than just the monetary policy shock, and their use as external instruments for identification is potentially compromised. Monetary ‘surprises’ are dependent on, and shown to be predictable by both central banks’ forecasts and past information available to market participants prior to the announcement. A New-Keynesian framework sketches the intuition. The resulting distortions in the estimated impulse response functions can be dramatic, both qualitatively and quantitatively. A new set of monetary surprises, free of anticipatory effects and unpredictable by past information, are shown to retrieve transmission coefficients to a monetary policy shock consistent with macroeconomic theory even in informationally deficient VARs.