Anticipation and Surprises in Central Bank Interest Rate Policy: The Case of the Bundesbank

Government officials, financial market participants and agents in the economy at large attach importance to official central bank interest rates. What are termed official rates typically comprise the rates applied at one or more central bank standing facilities and in some cases that at which the central bank operates a regular tender. In most industrialized countries, as in a number of developing countries, the central bank determines these rates in order both to define the range within which it manages short-term interbank rates through on-going open market operations, and to signal its short- to medium-term policy stance (see Borio (1997) for a recent survey). A change in official rates can thus affect expectations that are reflected in longer-term interest rates and other financial market prices, and hence initiate the monetary policy transmission process. Therefore policymakers need to be able to predict the market response to such changes, and if possible manage this response by explaining its actions. Yet market participants have an incentive to anticipate policy shifts, and insofar as they succeed, market prices should adjust in advance of the implementation of a change. Estimation of the reaction to a change in official rates, decomposed into its anticipated and unanticipated components, can be regarded as a test of market efficiency, and of whether the central bank can achieve different ends depending on the nature and degree of forewarning has been given of the change. These considerations were the motivation for this paper.