FMPAF: How Do Fed Chairs Affect the Financial Market? A Fine-grained Monetary Policy Analysis Framework on Their Language
This work addresses the need for more nuanced analysis of central bank communication for policymakers and financial market participants, though it is incremental as it builds on existing methods by incorporating LLMs.
The study tackled the problem of analyzing Federal Reserve chairs' communication impact on financial markets by proposing FMPAF, a framework integrating large language models with regression analysis, finding that a one-unit increase in sentiment score increases S&P 500 ETF prices by 500 basis points and decreases policy interest rates by 15 basis points, with no significant effect on exchange rates.
The effectiveness of central bank communication is a crucial aspect of monetary policy transmission. While recent research has examined the influence of policy communication by the chairs of the Federal Reserve on various financial variables, much of the literature relies on rule-based or dictionary-based methods in parsing the language of the chairs, leaving nuanced information about policy stance contained in nonverbal emotion out of the analysis. In the current study, we propose the Fine-Grained Monetary Policy Analysis Framework (FMPAF), a novel approach that integrates large language models (LLMs) with regression analysis to provide a comprehensive analysis of the impact of the press-conference communications of chairs of the Federal Reserve on financial markets. We conduct extensive comparisons of model performance under different levels of granularity, modalities, and communication scenarios. Based on our preferred specification, a one-unit increase in the sentiment score is associated with an increase of the price of S\&P 500 Exchange-Traded Fund by approximately 500 basis points, a 15-basis-point decrease in the policy interest rate, while not leading to a significant response in exchange rates.