16 Jun 2014

Central banks'' communications about financial stability can have a significant impact on the stock market, according to new research by Benjamin Born, Michael Ehrmann and Marcel Fratzscher. Their study, published in the June 2014 issue of the Economic Journal, analyses a unique dataset covering more than 1,000 releases of Financial Stability Reports (FSRs) and speeches by 37 central banks over the past 14 years. Among the findings:

• Central banks'' communications on financial stability have important repercussions for share prices. FSR releases move equity markets by more than 1% during the subsequent month and they also reduce market volatility.

• The effects of FSRs and speeches depend crucially on market conditions and other factors. The effects are particularly strong if the FSR contains an optimistic assessment of the risks to financial stability.

• Speeches and interviews typically have only modest effects on stock market returns and tend not to reduce market volatility.

• But during the financial crisis, FSRs were moving markets less than before the crisis, while speeches by central bank governors started to have more of an impact on markets.

The authors explore the mechanisms by which central banks'' communications about financial stability influence markets. Their results indicate that it is primarily via a coordination channel (the information content allows market participants to update their views about risks to financial stability) as opposed to a signalling channel (according to which the communications would provide information about upcoming policy decisions).

The study notes that while the release schedule of FSRs is pre-determined, speeches and interviews provide a much more flexible communication tool. For example, their number is positively correlated with market volatility.

Since it is often at the discretion of the central bank governors whether or not to make statements about financial stability, the fact that a governor feels compelled to raise financial stability issues in a speech or interview can therefore be an important additional news component.

In contrast, due to the fixed release schedule for FSRs, markets expect statements about financial stability issues on the release days. There might be surprising elements in their content, but the mere fact that the FSR is released does not come as a surprise. This difference might be at the heart of the different effects of the two instruments on market volatility.

The global financial crisis has triggered heated discussions on how to best achieve financial stability in the future. An important role has been assigned to central banks, many of which either already had or have been given explicit financial stability mandates.

In light of this, a large number of central banks have communicated extensively on financial stability-related matters – for example, through the publication of FSRs and financial stability-related speeches and interviews.

The empirical findings of this study raise a number of policy issues. Communication on financial stability by a central bank has been watched closely and is likely to be watched even more closely in the future by markets. The authors conclude:

''Our findings confirm that communication by monetary authorities on financial stability issues can influence developments in financial markets. Yet they also show that such communication may unsettle markets.

''Hence, central banks'' communications on financial stability need to be employed with utmost care, recognising the difficulty of designing a successful communication strategy on these matters.''

''Central Bank Communication on Financial Stability'' by Benjamin Born, Michael Ehrmann and Marcel Fratzscher is published in the June 2014 issue of the Economic Journal. Benjamin Born is at the University of Mannheim. Michael Ehrmann is at the Bank of Canada. Marcel Fratzscher is at the Deutsches Institut fuer Wirtschaftsforschung.

Marcel Fratzscher

European Central Bank | +49 69 1344 6871 | Marcel.Fratzscher@ecb.int; MFratzscher@diw.de

Benjamin Born


Michael Ehrmann