RDP 2003-05: What do Financial Market Data Tell us About Monetary Policy Transparency? 1. Introduction

During the past 10 to 15 years, central banks around the world have taken a number of steps to improve the effectiveness of their communication about monetary policy decisions and their rationale. In Australia there were a number of important changes including the introduction of announcements for changes to the target cash rate from January 1990, the subsequent adoption of an inflation target and the formalisation of the targeting framework in the Statement on the Conduct of Monetary Policy in 1996. These changes had the effect of making explicit the Reserve Bank's framework of instruments and objectives for monetary policy. In addition, there has been a significant expansion in the Bank's published commentary and analysis relating to the economy and monetary policy in recent years. This has taken place through a number of devices including the quarterly Statement on Monetary Policy, Bulletin articles, public addresses and reporting by the Governor to the House of Representatives Standing Committee on Economics, Finance and Public Administration.

These developments, often referred to under the general heading of increased transparency, might be expected to have resulted in financial markets being better informed and therefore better able to anticipate policy decisions and respond more efficiently to economic data than was formerly the case. This paper attempts to discern from financial market data the extent to which this has occurred in Australia and, where possible, to provide comparisons with results in similar countries. We find that: (i) interest rate volatility at the short end of the yield curve has fallen dramatically since the late 1980s; (ii) the extent to which market participants anticipate changes in the policy rate has gradually risen; (iii) the speed of reaction to interest rate announcements has increased; and (iv) bill futures contract prices appear to respond to RBA commentaries on the economy. These results are consistent with an increase in the efficiency with which the market digests economic news. However, it is difficult to isolate from cross-country data any specific preferred model of monetary policy transparency.