The Value of Understanding Central Bank Communication

This paper examines whether the communication of a central bank can complement its actions to coordinate market expectations and ultimately steer long-term interest rates. More specifically, we propose a measure of common understanding between the central bank and market participants and we assess how it alters the sovereign yield spreads of a sample of core and distressed countries in the euro area. We build a latent semantic analysis of the official transcripts of the press conferences that the European Central Bank holds at the end of each reserve maintenance period. We report empirical evidence supporting the importance of communication for implementing monetary policy decisions. Specifically, we show that the communication of the ECB was altered by the announcement of unconventional measures and that it significantly impacted sovereign spreads in the euro area.