Date of Award

8-2024

Degree Name

Doctor of Philosophy

Department

Economics

First Advisor

Matthew Higgins, Ph.D.

Second Advisor

Eskandir Alvi, Ph.D.

Third Advisor

Kevin Corder, Ph.D.

Keywords

A component GARCH, event study regression, information effect, monetary policy announcements, target and path surprises, volatility components

Abstract

This dissertation comprises three independent essays that contribute to understanding the impacts of monetary policy announcements on financial markets and the banking industry.

The first essay studies a natural language analysis of FOMC statements to identify monetary policy and its effects on financial markets. Using structural topic modeling, in the first essay I identify three dimensions of Fed monetary policy announcements: inflation outlook, state of the economy, and policy stance factors. This article focuses on the qualitative information released by the Fed through the FOMC statement, which has previously been overlooked in favor of quantitative communication such as the Green Book forecast and high-frequency financial variables (Bauer and Swanson (2022)). After identifying the optimal number of factors, high-frequency time series event study regressions are used to estimate the effects of the three factors on changes in high-frequency financial variables in 30-minute and one-day windows. Results indicate that these three factors account for an average of 15% of the variation in Fed funds futures and Eurodollar futures prices. I find that short-term and long-term Treasury yields, exchange rates, and inflation expectations respond positively to the inflation outlook factor and negatively to the policy stance factor. To estimate the effects of monetary policy shocks on low-frequency macroeconomic and financial variables, the study uses a proxy SVAR model, orthogonalizing the raw monetary policy surprises to the three factors and using them as an external instrument. The results confirm theoretical predictions that the shock reduces prices and industrial production. This paper documents the predictability of the monetary policy surprises by these factors and their effect on estimates of the response of the macroeconomy to monetary policy shocks. The study provides evidence of an information effect in Fed policy announcements, demonstrating that the content of Fed communication can have significant effects on financial and macroeconomic variables.

The second essay establishes the relationship between monetary policy announcements and financial market volatility. Monetary policy announcements exert a direct and substantial impact on the levels of uncertainty and fluctuations experienced within financial markets. This research focuses on the volatility of financial markets, which is one of the channels through which monetary policy affects risk-taking. Monetary policy surprises are decomposed into target and path surprises to capture the information effects of the Federal Reserve (Gurkaynak, Sack, and Swanson (2005)). The finding shows that monetary policy surprises have a significant impact on the long-term aspects of financial market volatility, specifically in the stock and bond markets. The effect of the target surprise on the long-term components of financial market volatility remains significant, regardless of whether it is estimated together with the path surprise or with other factors. Furthermore, path surprises have an increasingly pronounced influence on the long-term component of treasury yield volatility as the term to maturity increases.

The third essay’s focus shifts to the impact of unconventional monetary policies on bank liability and asset structures. This paper examines the effect of unconventional monetary policy, such as quantitative easing and forward guidance, on bank balance sheets. The study uses market-based measures of monetary policy stance to examine the impact of unconventional monetary policies on both the liability and the asset side of banks’ balance sheets. Unlike previous research that concentrated solely on the asset side of banks’ balance sheets, the study examines how different liability components respond to unexpected monetary policy changes. The findings show that unconventional monetary policy significantly affects bank liability ratios. For example, the Fed funds rate shock exerts pronounced and lasting effects on the loan-to-deposit ratio, aligning with theories that emphasize medium-term adjustments in lending behavior. Furthermore, our analysis reveals the resilience of the cash-to-deposit ratio against large asset purchase and forward guidance shocks. However, forward guidance does exhibit a notable impact on the loan-to-deposit and non-core liability ratios.

Collectively, these essays provide a diverse channel through which Fed monetary policy announcements influence financial markets and the banking industry, offering insights that contribute to the broader understanding of the complexities inherent in monetary policy transmission mechanisms.

Access Setting

Dissertation-Open Access

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