Underestimated effects of the termination of QE and forward guidance

October 25, 2014

It is evident that non-conventional Fed policy has contributed to long-term yield compression. It is less evident how this exactly worked and what will happen when the Fed tries to terminate QE and forward guidance. A new IMF paper supports evidence for two underestimated effects. First, to maintain existing stimulus the Fed must constantly announce new asset purchases or holding period extensions. Second, the stimulus from asset purchases depends on forward rate guidance and hence may decrease when the latter ceases.

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The Federal Reserve’s increased influence on financial markets

August 23, 2014

A new empirical study suggests that the Federal Reserve has exerted a stronger influence on fixed income, commodity, and currency markets since it started using non-conventional monetary policy. This is not because monetary policy shocks have been larger, but because their transmission has become more powerful and pervasive.

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The Federal Reserve’s reliance on macroprudential policy

July 5, 2014

In a recent speech Federal Reserve Chair Yellen has emphasized the economic cost of making financial risk a key consideration of monetary policy. While accommodative and non-conventional monetary policy may boost risk taking, enhanced regulation should secure financial system resilience and contain excesses. Only when macroprudential policy cannot achieve that goal should monetary policy step in. That time would not be now.

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The Federal Reserve’s strategy after tapering

May 25, 2014

William Dudley provided an update of the Fed’s strategy for normalizing monetary policy. Under appropriate economic conditions, policy rates could begin rising in 2015, a considerable time after open-ended asset purchases have ceased. Rates increases would be tempered by tightening financial conditions and are seen to converge on a level below 4%. Discretionary balance sheet reduction should follow, not precede, rates normalization. Large excess reserves are not expected to compromise control over short-term interest rates.

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How Fed asset purchases reduce yield term premia

February 15, 2014

An updated Federal Reserve paper suggests that there has long been a link between the net supply of government securities and term premia on Treasury yields. A 1%-point reduction in the ratio of Treasuries or MBS (10-year equivalent) to GDP supposedly reduced the 10-year term premium by 10 basis points. A one-year shortening of the average effective duration would lower the ten-year Treasury yield by about 7 basis points. Based on these estimates, the 2008-2011 large scale asset purchase and maturity extension programs of the Federal Reserve could have reduced the 10-year term premium by a total of 150 basis points.

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A review of Fed forward guidance and maturity extension

December 3, 2013

The Federal Reserve’s forward guidance and maturity extension policies demonstrated how non-conventional monetary policy operates through both “signaling effects” and “portfolio effects” Forward guidance reduced yields beyond the guidance period. It was treated by markets as a broader commitment to lasting accommodation, underscoring the power of signaling. The Maturity Extension Program, by contrast, raised shorter-dated rates, even within the forward guidance window, illustrating the general importance of the “portfolio effect”.

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Understanding the U.S. monetary policy framework

November 10, 2013

A new staff paper summarizes the Federal Reserve’s policy framework, as it evolved in the face of the zero lower bound for interest rates. The framework is predicated on the principles of excess stimulus, history dependence, economic conditionality, and credible communication. Its main tools are interest rate forward guidance and asset purchases. A higher inflation target or a nominal income level target is under discussion. The integration of monetary and macro-prudential policies has progressed.

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The U.S. Fed’s new tools to control short-term rates

October 3, 2013

A Federal Reserve paper describes and evaluates monetary policy tools for managing short-term market rates in an environment of large-scale excess reserve money in the financial system. These tools are interest on excess reserves (IOER), reverse repurchase agreements (RRPs) with a wide range of market participants, and the term deposit facility (TDF).

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Quantifying the impact of monetary policy rate guidance

August 3, 2013

A new DNB paper suggests that announcements by the U.S. Federal Open Market Committee on forward policy rate guidance have been credible and significantly reduced forward interest rates. Thus on average from 2008 to 2012, guidance announcements cut Eurodollar deposit rate 3 years forward by 14bps and 4-5 year forward Treasury yields by 20-21bps, over and above the impact of quantitative easing measures.

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