First Impressions Matter: Signalling as a Source of Policy Dynamics

Authors: Michael F. McMahon and Stephen E. Hansen

Review of Economic Studies, Vol. 83, No 4, 1645-1672, February, 2016

We provide the first direct empirical support for the importance of signalling in monetary policy by testing two key predictions from a novel structural model. First, all policymaker types should become less tough on inflation over time, and, second, types that weigh output more should have a more pronounced shift. Voting data from the Bank of England’s Monetary Policy Committee strongly supports both predictions. Counterfactual results indicate signalling has a substantial impact on interest rates over the business cycle, and improves the committee designer’s welfare. Implications for committee design include allowing regular member turnover and transparency regarding publishing individual votes.

This paper originally appeared as Barcelona GSE Working Paper 572