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1: Monetary policy surprises and the bank bill term premium.(Report)
Abstract: Has Australia's shift to an inflation-targeting monetary policy regime had a significant impact on investors' perception of interest-rate risks' in the market? We find that since 1990, unanticipated adjustments to monetary policy have had a significantly larger impact on the term premium. This coincides with Australia's adoption of an inflation-targeting monetary policy. Since its implementation, unanticipated adjustments have conveyed more information to financial markets regarding the interest-rate risks in the economy. This new information is immediately assessed and accounted for in the term structure, consequently influencing the term premium in the direction of the unanticipated cash rate adjustment.
Keywords: UNANTICIPATED MONETARY POLICY; TERM PREMIUM.
1. Introduction
Monetary policy is a key tool in managing the overall financial health of an economy, as it dictates the terms and conditions with which money and credit are provided to market participants. Financial markets eagerly await and anticipate any changes in monetary policy, as ripples are sent throughout the financial markets the moment an unanticipated policy adjustment is announced. This phenomenon occurs as any shift in the stance of monetary policy has a substantial bearing on the pricing of assets through its impact on the aggregate demand and the business cycle, the cost of financing investment projects, and the pricing of opportunity costs. The Reserve Bank of Australia (RBA) implements monetary policy during monthly board meetings throughout the year. As such, the dates of adjustments to policy are known in advance by the markets, and policy changes anticipated by the markets are impounded in the term structure of interest rates prior to the time of announcement.
Australia's monetary policy evolved from being a macroeconomic instrument whose policy adjustments occurred sporadically, were unannounced, and were unexplained to the markets, to one that is intent on pursuing a transparent inflation target of 2 to 3 per cent over the medium term. Throughout the 1980s, the RBA followed no clear target and instrument when implementing monetary policy; following what was known as the 'checklist' and unconstrained policy frameworks (see Section II for a concise review). However in 1989, the then Governor of the RBA, Ian Macfarlane, issued a statement summarising the current monetary policy regime (Macfarlane 1989):
'The cash rate is the instrument of monetary policy, there is no intermediate objective, and the ultimate objective has to be a nominal variable, such as the rate of inflation or nominal GDP.'
It was not until August 1996 that the Reserve Bank issued the Statement of Monetary Policy, formalising the instrument and targets of monetary policy. It reaffirmed the cash rate as the instrument of Australia's monetary policy and articulated the ultimate objective as maintaining underlying inflation between 2 to 3% over the course of the business cycle.
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