Bounded Rationality in Central Bank Communication

TL;DR

This paper investigates how FOMC communication influences market expectations by analyzing sentiment differences between experts and non-experts, revealing distinct expectation formation processes and the importance of tailored communication strategies.

Contribution

It introduces a bounded rationality model incorporating sentiment analysis to differentiate expert and non-expert responses to FOMC communication.

Findings

Experts form more conservative inflation expectations.

Non-experts react more directly to inflation concerns.

Institutions adjust expectations faster than individuals.

Abstract

This study explores the influence of FOMC sentiment on market expectations, focusing on cognitive differences between experts and non-experts. Using sentiment analysis of FOMC minutes, we integrate these insights into a bounded rationality model to examine the impact on inflation expectations. Results show that experts form more conservative expectations, anticipating FOMC stabilization actions, while non-experts react more directly to inflation concerns. A lead-lag analysis indicates that institutions adjust faster, though the gap with individual investors narrows in the short term. These findings highlight the need for tailored communication strategies to better align public expectations with policy goals.