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December 23, 2004
Open Mouth Operations
Michael Dueker and Andreas Fischer discuss an interesting case of central bank communications policy in the January issue of the St. Louis Fed's Monetary Trends. Here's how they describe "open mouth operations":
A narrow definition of open mouth operations concerns the ability of the central bank to achieve changes in its target interest rate without corresponding open market operations. A broader definition of open mouth operations,however, would include the proposition that the central bank can alter the slope of the yield curve at the very short end (at maturities between the overnight rate and 3 months,for example) through an announcement regarding a target rate change.
Their case study is based on two policy-rate hikes by the Swiss National Bank this summer and fall. In the first, the target rate was achieved with minimal market intervention -- an indication, say the authors of successful open-mouth operations. The second, however, required more substantial explicit open-market operations, leading Dueker and Fischer to conclude
... these two episodes suggest that policy announcements — open mouth operations—can cause rate spreads to deviate temporarily from their expected levels, although not necessarily on a regular basis or for an extended period of time.
... clear and open communication enhances the effectiveness of monetary policy--the channel that will be the focus of my remarks today--is by helping to align financial-market participants' expectations about the future course of monetary policy more closely with the policy committee's own plans and projections. As I will discuss, to the extent that central bank talk provides useful guidance to markets about the likely future path of short-term interest rates, policymakers will exert greater influence over the longer-term interest rates that most matter for spending decisions. At the same time, expanding the information available to financial-market participants improves the efficiency and accuracy of asset pricing. Both of these factors enhance the effectiveness and precision of monetary policy.
This is not to say, of course, that central bankers can live by open-mouth operations alone.
To be absolutely clear, in pointing out the benefits of clear communication I am not asserting that central bank talk represents an independent tool of policy. Indeed, if the central bank's statements are not informative about the likely future course of the short-term interest rate, they will soon lose their ability to influence market expectations. Rather, the value of more-open communication is that it clarifies the central bank's views and intentions, thereby increasing the likelihood that financial-market participants' rate expectations will be similar to those of the policymakers themselves--or, if views differ, ensuring at least that the difference can not be attributed to the policymakers' failure to communicate their outlook, objectives, and strategy to the public and the markets.
In the speech, Bernanke discusses his view on the importance of open-mouth operations in the implementation of recent U.S. monetary policy. Given the Federal Open Market Committee's recent decision to expedite the release of meeting minutes, perhaps another interesting experiment is right around the corner.
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