How central bank independence shapes monetary policy communication: A Large Language Model application

Abstract

Although central bank communication is a core monetary policy and accountability tool for central banks, little is known about what shapes it. This paper develops and tests a theory regarding a previously unconsidered variable: central bank independence (CBI). We argue that increases in CBI alter the pressures central banks face, compelling them to address these pressures to maintain their reputation. We fine-tune and validate a Large Language Model (Google’s Gemini) to develop novel textual indices of policy pressures regarding monetary policy communication of central banks in speeches of 100 central banks from 1997 to 2023. Employing a staggered difference-in-differences and an instrumental variable approach, we find robust evidence that an increase in independence decreases the narrow focus on price stability and increases financial pressures discussed in monetary policy communication. These results are not, as generally is assumed, confounded by general changes in communication over time or singular events, in particular, the Global Financial Crisis.