1 Why should central banks avoid surprising financial markets? In recent decades, it has been increasingly acknowledged that monetary policy implementation relies importantly on the management of market expectations. 2 In theory, clarity about the central bank’s reaction function--that is, how the central bank adjusts the stance of monetary policy in response to changing economic conditions--allows the market to alter financial conditions smoothly.
This typically helps meet the bank’s policy targets, with the result that the markets are working in alignment with the policymaker’s goals. Under  1  I am grateful to Joseph Gruber and Don Kim of the Federal Reserve Board for their assistance. The views expressed are mine and not necessarily those of the Federal Reserve Board or the Federal Open Market Committee.