Face of inflation: What central bankers’ expressions tell us about monetary policy

After announcing a half-point interest rate increase in October, Tiff Macklem took to the stage in the Bank of Canada building in Ottawa to explain the hike.

“There are no easy outs to restoring price stability,” the central bank Governor said slowly and deliberately, with the tone of a parent lecturing teenagers about homework.

“But once we get through this slowdown, growth will pick up, our economy will grow solidly, and the benefits of low and predictable inflation will be restored,” he continued. There was a notable uptick in his intonation, as if to signal sunnier days ahead.

Communication is a key part of monetary policy. Central bankers can move markets with their words, reinforcing or undermining the more mechanical aspects of interest rate policy. How they say those words, it turns out, can also influence markets, according to recent research from the Bank of Canada.

Bank researchers, working with University of Toronto economics professor Michelle Alexopoulos, looked at whether the vocal tone and facial expressions of then U.S. Federal Reserve chairs Ben Bernanke and Janet Yellen influenced stock prices and market volatility.

Using facial recognition, text and voice analysis software, the researchers poured over videos of Mr. Bernanke and Ms. Yellen addressing the U.S. Congress from 2010 to 2017.

The facial recognition software scanned for negative emotions – such as a furrowed brow or tensed lower eyelids – while the voice analysis software looked for shifts in tone. This so-called “soft information” was mapped second-by-second against changes in the S&P 500 stock index and VIX index, which measures market volatility.

The results were striking but also intuitive. Positive emotional changes tended to raise stock prices and lower volatility, while the opposite was true of negative emotions. Moreover, the market was notably more sensitive to changes in vocal tone and facial expression than to changes in the sentiment of the words themselves.

The market moves were small – typically a few basis points – but “economically significant,” the researchers said. (A basis point is one-hundredth of a percentage point).

“If accumulated over the entire testimony, the effects of soft information from the Fed Chair may reach magnitudes comparable to those after an interest rate cut. For example, an unanticipated 25 bps cut in the Fed funds rate is associated with a roughly 100 bps increase in stock prices,” Prof. Alexopoulos, Xinfen Han, Oleksiy Kryvtsov and Xu Zhang wrote in the paper, published by the Bank of Canada in May.

This echoes other recent academic papers. For example, a team of economists led by Yuriy Gorodnichenko of the University of California, Berkeley, found that the tone used by Fed chairs during news conferences can “materially move the financial markets.”

“Switching the tone of the press conference from negative (-1) to positive (+1) could raise S&P 500 returns by approximately 200 basis points,” Prof. Gorodnichenko and his co-authors Tho Pham and Oleksandr Talavera wrote in a 2021 paper.

In some ways, the research is a modern confirmation of central banking lore. In the 1920s – a time when central bankers put very little stock in public communication – then-Bank of England governor Montagu Norman’s eyebrows became a famous weathervane for monetary policy.

“The Governor’s eyebrows were, in a way, a primitive form of emoji: sterling crisis – sad face, bad pre-[Monetary Policy Committee] presentation – very sad face,” former Bank of England chief economist Andrew Haldane quipped in the text of a 2017 speech. “Nonetheless, for even the most malleable-faced Governor, the eyebrows were an imperfect communications medium.”

There have been other attempts over the years to find non-verbal hints of where monetary policy is going. In the 1990s, financial journalists got into the habit of looking at the thickness of then-Fed chair Alan Greenspan’s briefcase on the day of rate decisions. If the briefcase was thick, he had a lot of explaining to do, which could indicate a change in policy – or so the thinking went.

Dubbed the “briefcase indicator,” it proved more amusing than accurate. As economists at the St. Louis Fed joked in a paper published in 2000: “It’s not the size of the briefcase that matters, but the type and quality of the information found inside.”

While briefcases may be the wrong places to look, emotions do sometimes tell important financial stories. Business professors at the University of Illinois and Duke University found a telling example in 2012, when they used voice analysis software to examine recordings of corporate earnings calls. They found that certain vocal cues by chief executives were a predictor of deceptive financial reporting, where companies had to restate financial results.

Does the importance of emotions mean that central bankers need to become actors, wiggling their eyebrows and modulating their voice to send messages to investors? Probably not, Prof. Alexopoulos said in an e-mail.

“It would be extremely difficult, if not impossible, for someone to fully control their microexpressions and vocal cues,” she said.

“[But] it is my hope that making policy makers more aware of the fact that soft information conveyed can influence responses to their statements, press conferences and other forms of bank communication helps increase the effectiveness of their communications.”

The Bank of Canada’s five governing council members have all taken training in public speaking, spokesperson Alex Paterson said in an e-mail. And Mr. Macklem and his deputies rehearse ahead of public appearances, “to make sure messages are coherent, clear and relatable.”

Mr. Paterson said the bank’s communications staff works with the governing council to gauge how Canadians are feeling about the economy and to frame public remarks in that light. But staff don’t try to get the country’s top monetary policy makers to ham it up.

“GC members are only advised to be sincere and forthright,” he said.