Itaú BBA - The Copom-o-meter and upcoming monetary policy meetings

Macro Vision

< Volver

The Copom-o-meter and upcoming monetary policy meetings

abril 19, 2016

We show that the Copom-o-meter is consistent with our scenario that the CB will start an easing cycle at its July meeting.

In the first “Copom Cockpit” report, we introduced the Copom-o-meter, an index that measures the degree of contraction or expansion indicated in communication from the central bank (CB). In this study, we present additional details about the index. We also show that the Copom-o-meter correlates with monetary policy decisions and is consistent with our scenario that the CB will start an easing cycle at its July meeting.

     1.Introduction

Communication is an important monetary policy tool, particularly in countries like Brazil that have adopted inflation-targeting regimes.[1]  As a result, there is a growing body of research on ways to measure the information contained in issued statements and other communication from policymakers.

In this study, we present additional details about the Copom-o-meter, an index that is based on written communications from the CB’s monetary policy committee (Copom) and tracks the degree of contraction or expansion indicated in these statements. Econometric exercises suggest that the Copom-o-meter is a good leading indicator of monetary policy decisions and is consistent with our scenario that the CB will start an easing cycle at its July meeting.

    2. How is the Copom-o-meter built?

The Copom-o-meter classifies changes (both inclusions and exclusions) in the Copom’s written statements as “hawkish” (+1), neutral (0) or “dovish” (-1). The index tracks such changes in three statement components: paragraphs about economic activity, paragraphs about inflation and paragraphs that include monetary policy signals.

Chart 1 shows how the Copom-o-meter and its composition have evolved in recent years. Overall, the inflation and activity components have tended to move in the same direction. In 2015, however, these components started moving in opposite directions, reflecting the negative supply shock represented by adjustments in relative prices (administrative prices and exchange rates). More recently, these components have once again started moving in the same direction.

For the March Copom-o-meter, in addition to analyzing the Copom minutes, we applied the methodology to the most recent speech given by central bank governor, Alexandre Tombini. Recently, the index has suggested that there are signs of a more hawkish approach to monetary policy, as the central bank has started emphasizing that current conditions “do not allow the Committee to work with the possibility of monetary flexibilization.” On the other hand, the inflation component has become more expansionary, as the CB has acknowledged that “the deflationary effects of monetary policy tend to outweigh the secondary effects of relative price changes in 2015.”

The Copom-o-meter variation is calculated by adding up the activity, inflation and monetary policy signaling components. As the index is calculated based on the changes between Copom minutes, we set the indicator to 100 in October 2010[2]  and then add up the subsequent variations in order to quantify the degree of contraction or expansion indicated by the CB’s latest communication.

Chart 3 compares the Copom-o-meter index evolution with the Selic benchmark rate decision at each subsequent meeting. The correlation between these two series is 0.51. To verify whether the indicator is able to predict a future monetary policy decision, we carried out a Granger causality test. The data presented in Table 1 (in the appendix) show that the Copom-o-meter indeed correlates to subsequent Selic rate decisions.


 

     3. The Copom-o-meter and upcoming monetary policy decisions

As explained in the previous section, the Copom-o-meter provides relevant information on future monetary policy decisions. For this reason, we have used the indicator to predict Selic benchmark rate changes for the next three Copom meetings (April, June and July) through a three-stage econometric exercise. In the first stage, we predicted the inflation and activity components based on the macroeconomic variables in our baseline scenario. In the second stage, we used these activity and inflation components to forecast the monetary policy signaling component. And finally, using the Copom-o-meter forecast, we projected the policy decisions for the next three meetings.

3.1 Inflation and activity component forecasts

In order to predict the inflation and activity components, we used our macroeconomic variable forecasts, which have a good correlation with these components. We used our diffusion index for the activity component.[3]  Graph 2 shows the relationship between the activity component’s moving average over eight meetings and our diffusion index. The correlation between the series is 0.87. The estimated model can be found in Table 2 of the appendix.

For the inflation component, our model used the variation in 12-month inflation expectations, exchange rate variation and our inflation surprise index[4]  (Table 3 of the appendix). Graph 3 compares the Copom-o-meter’s inflation component with inflation expectations. The correlation between the series is 0.32.

   

Using the estimated models and taking into account the variables from our baseline scenario, the results suggest that the central bank will take a looser approach to the inflation component at its June meeting, and that it will also take a looser approach to the activity component at its July meeting.

3.2 Forecasting the monetary policy signaling component

We use the inflation and activity components (Table 4 of the appendix) to calculate the monetary policy signaling component. Looking at the next three meetings and based on our projections for the activity and inflation components, the model suggests that monetary policy signaling statements are likely to be more expansionary at the June meeting.

3.3 Upcoming monetary policy meetings

In this stage, we used our Copom-o-meter forecast to predict the Copom’s decisions at its next three meetings (Table 5 of the appendix). Based on our Copom-o-meter forecasts, the model suggests approximately a 0.25-pp rate cut at the July meeting. In our baseline scenario, we are forecasting a 0.50-pp cut at the July meeting. The following table summarizes the model’s results and our baseline forecasts.

     4. Conclusion

This article contains additional details on the Copom-o-meter, an indicator that tracks the content of central bank statements. Based on our econometric exercises, we conclude that the Copom-o-meter is a good leading indicator of future monetary policy decisions. The Copom-o-meter is currently pointing approximately to a 0.25-pp cut in the Selic rate in July. In our base-case scenario, the Copom does start an easing cycle in July, but we believe that it will opt for a sharper cut of 0.50 pp.


 

Caio Megale

Laura Pitta