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The zero lower bound, forward guidance and how markets respond to news

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  • Richhild Moessner
  • Phurichai Rungcharoenkitkul

Abstract

Short-term market interest rates seem to have been less responsive to economic news in the post-crisis period. We evaluate two potential reasons: forward guidance and the constraint on monetary policy imposed by the zero lower bound (ZLB). We quantify how the ZLB has dampened market reactions to news in the United States, using estimates of the probability of hitting the ZLB derived from overnight index swap rates. For short maturities, variations in the ZLB's probability are sufficient to account for the fall in the sensitivity of market interest rates while the ZLB was binding. However, since it was precisely at the ZLB that forward guidance was most actively used, its role cannot be ruled out. But even after the policy rate rose, significantly reducing the ZLB's probability, the market's response to news continued to be more muted for shorter-maturity bonds and some risky assets. This suggests that other mechanisms also played a part, including forward guidance about gradual policy rate normalisation.

Suggested Citation

  • Richhild Moessner & Phurichai Rungcharoenkitkul, 2019. "The zero lower bound, forward guidance and how markets respond to news," BIS Quarterly Review, Bank for International Settlements, March.
    • Handle: RePEc:bis:bisqtr:1903h
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    References listed on IDEAS

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    Cited by:

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    2. Jung, Alexander & Uhlig, Harald, 2019. "Monetary policy shocks and the health of banks," Working Paper Series 2303, European Central Bank.
    3. Cawley, Cormac & Finnegan, Marie, 2019. "Transmission channels of central bank asset purchases in the Irish economy," MPRA Paper 96547, University Library of Munich, Germany.
    4. Cour-Thimann, Philippine & Jung, Alexander, 2020. "Interest rate setting and communication at the ECB," Working Paper Series 2443, European Central Bank.
    5. Julián Caballero & Blaise Gadanecz, 2023. "Did interest rate guidance in emerging markets work?," BIS Working Papers 1080, Bank for International Settlements.
    6. Silvia T. Trifonova, 2023. "New Trends In The European Central Bank Monetary Policy," Economy & Business Journal, International Scientific Publications, Bulgaria, vol. 17(1), pages 39-60.
    7. Cormac Cawley & Marie Finnegan, 2019. "Transmission Channels of Central Bank Asset Purchases in the Irish Economy," Economies, MDPI, vol. 7(4), pages 1-25, September.
    8. Cour-Thimann, Philippine & Jung, Alexander, 2021. "Interest-rate setting and communication at the ECB in its first twenty years," European Journal of Political Economy, Elsevier, vol. 70(C).
    9. Jung, Alexander, 2023. "Are monetary policy shocks causal to bank health? Evidence from the euro area," Journal of Macroeconomics, Elsevier, vol. 75(C).
    10. Galati, Gabriele & Moessner, Richhild, 2021. "Effects of Fed policy rate forecasts on real yields and inflation expectations at the zero lower bound," Economics Letters, Elsevier, vol. 198(C).

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    More about this item

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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