Differences between Central Bank and Private Sector Policy Rate Forecasts: Causes and Implications for Monetary Policy

Abstract

I document differences in interest rate expectations between central banks and the private sector and show why such a gap is a puzzle. I then create a measure of central bank credibility by taking the absolute value of the difference in expectations, which I use in an event study across several countries to demonstrate that a decrease in credibility can reduce the efficacy of forward guidance. I also offer several possible explanations for differences in interest rate expectations. In particular, I find that some of this gap must be attributed to differences in beliefs about the central bank's reaction function.

Keywords: Interest Rate Expectations, Central Bank Communication, Forward Guidance, Credibility, Financial Markets

JEL Classification: E52, E58, E43