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September 20, 2004
When the FOMC Talks, People (Apparently) Listen
Last week, Federal Reserve Board Governor Ben Bernanke presented a paper to the Brookings Panel on Economic Activity that studied the effects of Federal Open Market Committee communications on market interest rates. The paper, summarized in Friday's Wall Street Journal (page A2) and co-authored with economists Vincent Reinhart and Brian Sack, aims to
... apply the tools of modern empirical finance to the recent experiences of the United States and Japan to provide evidence on the potential effectiveness of various nonstandard policies... we group these policy alternatives into three classes: (1) using communications policies to shape public expectations about the future course of interest rates; (2) increasing the size of the central bank’s balance sheet, or “quantitative easing”; and (3) changing the composition of the central bank’s balance sheet through, for example, the targeted purchases of long-term bonds as a means of reducing the long-term interest rate.
The results make policymakers -- US policymakers in any event -- look pretty darn smart.
Our results provide some grounds for optimism about the likely efficacy of nonstandard policies. In particular, we confirm a potentially important role for central bank communications to try to shape public expectations of future policy actions. Like Gürkaynak, Sack, and Swanson (2004), we find that the Federal Reserve’s monetary policy decisions have two distinct effects on asset prices. These factors represent, respectively, (1) the unexpected change in the current setting of the federal funds rate, and (2) the change in market expectations about the trajectory of the funds rate over the next year that is not explained by the current policy action. In the United States, the second factor, in particular, appears strongly linked to Fed policy statements, probably reflecting the importance of communication by the central bank. If central bank “talk” affects policy expectations, then policymakers retain some leverage over long-term yields, even if the current policy rate is at or near zero.
We also find evidence supporting the view that asset purchases in large volume by a central bank would be able to affect the price or yield of the targeted asset.
There are, of course, plenty of caveats about the study, about which the authors are completely forthright. For example, a good deal of the evidence pertains to the reaction of bond markets on the same day of policy changes -- the evidence on the persistence of these effects is somewhat more tenuous. It's still a pretty interesting read, and has a handy executive summary for those who are not real keen on wading through all 113 pages.
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