Disagreement About Monetary Policy

Abstract

Using a model of monetary policymaking with belief distortions, I propose tests to distinguish among three leading explanations for disagreement between markets and central banks: asymmetric information, different beliefs about the monetary rule, and different confidence in public signals. Implementing these tests in US data, I find that bad macroeconomic news predicts market over-estimation of both interest rates and employment relative to realizations and Federal-Reserve forecasts. I show that different confidence in public signals is necessary to explain these findings. Quantitatively, this mechanism significantly dampens market beliefs’ responsiveness to fundamentals. Central-bank signaling about fundamentals, by contrast, has much smaller effects.

Keywords: monetary policy, disagreement, high-frequency identification

JEL Classification: E52, D84, E44, G14