News Uncertainty and Signaling Effects of Monetary Policy

I investigate how news uncertainty influences the signaling effects of monetary policy, a key element for understanding how central bank communication impacts households and firms. Utilizing a monetary policy news uncertainty index from newspaper data, I apply a smooth transition local projection model to examine the effects of contractionary monetary shocks under varying levels of news uncertainty. I find that under high news uncertainty, inflation expectations, and output rise—contrary to the central bank’s goals—demonstrating the price and output puzzles. However, when news uncertainty is low, these variables decrease as expected following contractionary policy shocks. My findings illustrate that high news uncertainty amplifies signaling effects, leading to unintended economic outcomes, whereas minimizing news uncertainty reduces these effects and supports the efficacy of traditional policy mechanisms. I propose two mechanisms : (1) households pessimistically misjudge monetary shocks in the opposite direction when conflicting media reports distort the information they receive, and (2) households misinterpret monetary policy as a signal of rising inflation, while firms misinterpret it as a combination of a positive preference shock and a negative productivity shock. These insights underline the importance of reducing news uncertainty through clear and consistent central bank communication.