Do ECB introductory statements help to predict monetary policy: evidence from tone analysis

In this paper, we examine whether a tone shock derived from ECB communication helps to predict ECB monetary policy decisions. For that purpose, we first use a bag-of-words approach and several dictionaries on the ECB’s Introductory Statements to derive a measure of tone. Next, we orthogonalize the tone measure on the latest data available to market participants to compute the tone shock. Finally, we relate the tone shock to future ECB monetary policy decisions. We find that the tone shock is significantly and positively related to future ECB monetary policy decisions, even when controlling for market expectations of economic conditions and monetary policy and the ECB’s Governing Council inter-meeting communication. Further extensions show that the predictive power of the tone shock regarding future monetary policy decisions is robust to (i) the normalization of the tone measure, (ii) alternative market expectations about monetary policy and (iii) the macroeconomic variables used in the Taylortype monetary policy. These findings thus highlight an additional channel by which ECB communication improves monetary policy predictability, and suggest that the ECB may have private information that it communicates through its Introductory Statements.