Assessing the Fed's Tools at the Zero Lower Bound
Forward guidance and large-scale asset purchases were effective alternatives when the Federal Reserve was unable to stimulate the economy by lowering interest rates.
From 2009 to 2015, when the Federal Reserve's target short-term interest rate was close to zero, the central bank employed two other mechanisms in its efforts to boost the economy: forward guidance — information about the future path of the short-term interest rate — and large-scale asset purchases (LSAPs). In Measuring the Effects of Federal Reserve Forward Guidance and Asset Purchases on Financial Markets (NBER Working Paper No. 23311), Eric T. Swanson reports that both tools had substantial impacts on medium-term Treasury yields, stock prices, and the value of the dollar — impacts not unlike those achieved by changes to the federal funds rate before 2009. Short-term Treasury yields responded more to forward guidance, while LSAPs had a more pronounced effect on longer-term Treasury and corporate bond yields, his study finds. The effects of LSAPs also seem to have been more persistent.
Decentralization Helps Firms Cope with Downturns
Measuring the market impact of the two nontraditional tools is difficult for a number of reasons. First, the Fed often made announcements about both tools at the same time, making it difficult to disentangle their financial market effects. Second, markets may have interpreted LSAP announcements as having forward-guidance-like implications for the future federal funds rate. Third, financial markets are forward-looking and typically respond only to the unexpected component of Fed announcements, but there is little or no data directly measuring market expectations of these unconventional monetary policy announcements by the Fed.
— Laurent Belsie
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