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| The Game of Expectations: Central Bank Communication and the Government Bond Yield Curve |
| SHANG Yuhuang, LIU Hua, SHEN Feng
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| Institute of Chinese Financial Studies/School of Finance, Southwestern University of Finance and Economics |
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Abstract In the context of declining effectiveness in traditional monetary policy tools, major central banks worldwide increasingly rely on public communication to support their policy objectives. At the 15th Lujiazui Forum in 2024, Governor Pan Gongsheng emphasized that “a key feature of the modern monetary policy framework is the central bank's ability to transparently and clearly communicate its policy considerations and future outlook to markets and the public,” underscoring the critical role of central bank communication in contemporary policy frameworks. Concurrently, the government bond yield curve, serving as a benchmark rate with a complete maturity structure, constitutes an essential component of China's interest rate system. As interest rate liberalization advances and the treasury bond market matures, the term structure of government bond yields increasingly reflects forward-looking market expectations. Notably, institutions such as the European Central Bank and the Bank of Japan have integrated yield curve analysis into their monetary policy frameworks. Consequently, strengthening the modern monetary policy framework necessitates leveraging both the signaling effects of central bank communication and enhancing the transmission efficiency of the yield curve.
Existing research on central bank communication and bond yields exhibits two primary limitations: First, there is a lack of systematic examination regarding the impact of communication across the entire yield curve. Second, existing literature has a predominant focus on the unidirectional influence of communication on market yields, overlooking the critical role of market feedback in policy formulation. To address these gaps, this study integrates central bank communication into a no-arbitrage term structure model grounded in financial market principles. By adopting mixed-frequency econometric methods, we incorporate information flows combining both high-and low-frequency data. This framework enables an investigation into the bidirectional interaction between central bank communication and government bond yields in China from 2002 to 2023. Utilizing textual analysis techniques, we construct a sentiment index for central bank communication and decompose communication content into two dimensions: economic/financial fundamentals and policy guidance. This decomposition allows for quantifying their differential impacts on the interest rate term structure.
This research overcomes challenges in modeling the “signaling mechanism” of central bank communication and addressing complexities in mixed-frequency data integration. Its contributions are threefold. First, by embedding central bank communication within a mixed-frequency affine term structure model under no-arbitrage constraints, it provides a novel perspective for evaluating the efficacy of communication strategies. Second, the application of textual analysis to measure communication sentiment enables precise identification of signaling mechanisms within mixed-frequency information environments, enhancing the accuracy and timeliness of expectations management assessment. Third, through the lens of signaling effects, it elucidates the bidirectional dynamics between communication and the term structure, revealing variations in transmission mechanisms and effectiveness across different economic conditions.
Empirical findings reveal three key insights. First, a bidirectional interaction exists between central bank communication and the yield curve: positive communication sentiment lowers the entire yield curve, narrows the term spread, and elevates medium-term yields; conversely, the slope and curvature factors of the yield curve significantly inform central bank communication decisions. Second, the expectation guidance effect of communication exhibits maturity-dependent heterogeneity, exerting a stronger influence on short-to-medium maturities than on the long end. Additionally, positive communication sentiment reduces risk premiums demanded by markets. Third, with the deepening of interest rate liberalization and refinement of communication practices, the guidance efficacy of the People's Bank of China's communication has strengthened, while market feedback increasingly informs communication strategies. Currently, signaling effects predominantly derive from historical economic and policy interpretations; the guiding potential of forward-looking policy signals remains underutilized.
This study offers empirical foundations and policy insights for optimizing central bank communication strategies and leveraging market signals to enhance monetary policy effectiveness. To strengthen expectation guidance, establishing tiered and differentiated communication channels could improve market comprehension. Simultaneously, central banks could deepen the extraction of medium-to-long-term growth signals embedded in the yield curve, utilizing communication to bolster market confidence in sustainable economic health.
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Received: 25 December 2024
Published: 02 October 2025
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