Thursday 28 Mar 2024
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ARE you looking for a way to study the economy’s health? Well, standard leading economic gauges commonly administered by a country’s statistical department (or any other independent body) are among the more reliable tools you could use.

For instance, in the US, the Conference Board Leading Economic Index (LEI) aggregates reliable sub-indicators that, over the years, helped to identify the turning points of business cycles. Similarly, Malaysia’s Department of Statistics (DoS) has its own leading indicator which is made available to the public to gauge general economic trends. Its components largely mirror those used in the US’ LEI, with both gauges using financial and non-financial sub-indicators.

But if you are looking for a viable alternative to the norm, try your hand at interpreting the language of central banks — not an easy task, to say the least, but distinctive past trends do provide some useful clues. This is true for both the US Federal Reserve (Fed) and Bank Negara Malaysia (BNM).

For the uninitiated, central banks’ monetary policy meeting statements are intended to enhance communication between policymakers and the public by shedding more light on the central banks’ respective policy stance as well as their intentions in guiding the economy forward.

By helping the public understand central bankers’ thoughts and concerns on the economy’s current state and future direction, inflationary expectations can be better anchored. This helps prevent the financial market from being unduly surprised when the central bank announces certain decisions, thus resulting in lesser financial-market volatility which is positive for the economy as a whole.

Therefore, studying the structure of monetary policy statements and parsing the words that are meticulously assembled are akin to assessing the body language of a person talking to us. Factors like number of words and sentences, complexity of the language used, as well as keywords found in the statements can provide valuable hints about how central banks feel about the state of the economy and what they plan (or don’t plan) to do in the near term.

In the Fed’s case, for instance, it is found that the number of words used in its Federal Open Market Committee (FOMC) statements has increased dramatically since the 2008-2009 Global Financial Crisis, from about 50-200 words in the early 1990s to 400-plus words by January 2009. Under Fed chairwoman Janet Yellen, the number of words exceeded 800 between March and September 2014.

Interestingly, readings of a readability measure that gauges the complexity of the statements (using the Flesch-Kincaid Grade Level index, or F-KGL) have also changed over the years. It was found that in the 1990s, reading grade levels were 9-14, meaning that they were “readable” to individuals with an education ranging from the first year of high school to two years beyond high school.

Under Yellen, all five statements up to September 2014 had reading grade levels of 18-19, meaning that an education level of about three years beyond a four-year college degree is needed to understand them.

So now, statements have apparently become lengthier and more complex. And of course, it is getting tougher than ever to fully comprehend the Fed’s messages, unless the reader has a degree-level education.

What about BNM’s Monetary Policy Committee (MPC) statements, you ask? MARC’s research team performed a similar analysis on them based on the number of words, readability index and their general trend. The Flesch Reading Ease (FRE) index and F-KGL, matched with local education attainment levels, were also plotted. We then discovered certain distinctive features.

First and foremost is the general uptrend in the number of words used since the first minutes were released, ranging from 76 words to 487 words between 2004 and March 2015. When a trend line was plotted, tightness of the data was observed, underscoring the general increase in the statements’ word count (see chart).

Additionally, it was found that the number of words in the MPC statements was generally higher prior to and during “economic shocks” like the recession in 2009 and the euro crisis (see shaded areas in the chart) with more than 400 words and 19 sentences per statement, compared with the long-term average of 279 words and 13 sentences, respectively. The spike in the statements’ word count prior to these economic shocks is an interesting phenomenon.

Another feature shared with FOMC statements is the increasing complexity of the MPC statements, based on the FRE and F-KGL measures. There was a general decline in FRE scores and rise in F-KGL readings, suggesting that statements are getting more complex over time, and more years of education are needed to fully comprehend them. Notably, the degree of complexity was higher during the recession with an FRE score that corresponds to an education level of a postgraduate.

Notwithstanding this, the MPC statements were very clear in giving signals about BNM’s future policy intentions. Certain keywords like “build-up” and “imbalances” were frequently found prior to interest rate movements. These are words that readers need to look for to make intelligent guesstimates about future policy actions.


Nor Zahidi Alias is chief economist of Malaysian Rating Corp Bhd

This article first appeared in Forum, The Edge Malaysia Weekly, on May 11-17, 2015.

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