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The effects of the Federal Reserve's date-based forward guidance

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  • Matthew D. Raskin
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    Abstract

    Between August 2011 and December 2012 the Federal Open Market Committee (FOMC) used date-based forward guidance to help stimulate the U.S. economy and promote its objectives of maximum employment and price stability. Some have argued that the formulation of the guidance that the FOMC used may have reduced interest rates primarily by signaling a weak economic outlook rather than by signaling a more accommodative stance of monetary policy. I examine the impact of the date-based guidance, with the principal goal of discerning the extent to which it altered investors' views of the FOMC's policy reaction function. I show that one seemingly straightforward way to address this question--using estimates of the sensitivity of money market futures rates to macroeconomic data surprises--is confounded by the zero lower bound on nominal interest rates, a point that has more general implications for the analysis of the effects of monetary policy at the zero bound. I demonstrate that the problem can be overcome using distributions of investors' short-term interest rate expectations constructed from interest rate options. Using PDFs constructed from these options, along with survey measures of macroeconomic surprises, I find the date-based guidance led to a statistically significant and economically meaningful change in investors' perceptions of the FOMC's reaction function. This finding is robust to various regression specifications and the use of alternative options contracts and PDF fitting methodologies.

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    Bibliographic Info

    Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2013-37.

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    Date of creation: 2013
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    Handle: RePEc:fip:fedgfe:2013-37

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    1. Eric T. Swanson, 2011. "Let's Twist Again: A High-Frequency Event-Study Analysis of Operation Twist and Its Implications for QE2," 2011 Meeting Papers 982, Society for Economic Dynamics.
    2. Yuriy Kitsul & Jonathan H. Wright, 2012. "The Economics of Options-Implied Inflation Probability Density Functions," NBER Working Papers 18195, National Bureau of Economic Research, Inc.
    3. Yuriy Kitsul & Jonathan H. Wright, 2012. "The Economics of Options-Implied Inflation Probability Density Functions," Economics Working Paper Archive 600, The Johns Hopkins University,Department of Economics.
    4. Meredith Beechey, 2006. "A closer look at the sensitivity puzzle: the sensitivity of expected future short rates and term premia to macroeconomic news," Finance and Economics Discussion Series 2007-06, Board of Governors of the Federal Reserve System (U.S.).
    5. Jonathan H. Wright, 2012. "What does Monetary Policy do to Long‐term Interest Rates at the Zero Lower Bound?," Economic Journal, Royal Economic Society, vol. 122(564), pages F447-F466, November.
    6. Richhild Moessner & William R. Nelson, 2008. "Central Bank Policy Rate Guidance and Financial Market Functioning," International Journal of Central Banking, International Journal of Central Banking, vol. 4(4), pages 193-226, December.
    7. James D. Hamilton & Jing Cynthia Wu, 2011. "The Effectiveness of Alternative Monetary Policy Tools in a Zero Lower Bound Environment," NBER Working Papers 16956, National Bureau of Economic Research, Inc.
    8. Michael A. S. Joyce & Ana Lasaosa & Ibrahim Stevens & Matthew Tong, 2011. "The Financial Market Impact of Quantitative Easing in the United Kingdom," International Journal of Central Banking, International Journal of Central Banking, vol. 7(3), pages 113-161, September.
    9. Jonathan Wright & Yuriy Kitsul, 2012. "The Economics of Options-Implied Inflation Probability Density Functions," 2012 Meeting Papers 174, Society for Economic Dynamics.
    10. Paul R. Krugman, 1998. "It's Baaack: Japan's Slump and the Return of the Liquidity Trap," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(2), pages 137-206.
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    Cited by:
    1. Maria Lucia Florez-Jimenez & Julian A. Parra-Polania, 2014. "Forward guidance with an escape clause: When half a promise is better than a full one," Borradores de Economia 811, Banco de la Republica de Colombia.

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