Increased transparency of central bank activity has replaced bank independence. The move towards transparency began in 1990 when New Zealand became the first country to announce interest rate targets prior to their implementation. Other countries soon followed. Central bank announcements have pervasive effects in any economy. Announcements provide information about the future path of interest rates which drives decision making by households, businesses and financial institutions. These announcements by the central bank can only achieve their desired effect if the transmission of monetary policy through market channels is efficient.
This paper examines the effects of official discount rate (ODR) changes on market interest rates in Asia. Research on the impact of ODR announcements in the United States has confirmed that bond yields, stocks prices and exchange rates all react on announcement dates. When a central bank changes the discount rate there is a parallel shift in the country’s term structure if rates are controlled. The 1990s saw many emerging countries liberalise their financial markets; and data are now available to test the impact of central bank announcements. Further, although each central bank makes decisions to impact the domestic economy, shocks are now transmitted beyond local borders.
We employ an event study methodology that examines both rate changes in own market, and those in countries that tend to lead interest rate changes. The effects are examined -10 to +10 days of the announcement date of changes. Our results confirm that short-term rates are the most responsive to ODR announcements while long term rates are not impacted. In addition, markets anticipate changes in target interest rates prior to the ODR announcements. The results are consistent with the hypothesis that increased transparency has reduced uncertainty about the economy for market participants, as opposed to earlier periods where central banks were shrouded in secrecy.
