Language after liftoff: Fed communication away from the zero lower bound
TL;DR: The authors argue that the Federal Reserve can improve communication in the current environment by moving away from time-based forward guidance, clarifying how interest rates are likely to change given new information, and providing more information in the Summary of Economic Projections, and argue that, except under unusual circumstances, this is an imprudent strategy as it mutes the effect of macroeconomic news on interest rates and unnecessarily places restrictions on future Federal Reserve action when new information arrives.
Abstract: This paper examines the Federal Reserve's communication strategy to see how well it has worked and how it can be improved. It argues that Federal Reserve communication when short-term interest rates are no longer constrained by the zero lower bound should be focused on relaying a data-based reaction function which informs market participants how interest rates will adjust as new information arrives. Instead, the Federal Reserve in recent years has relied more heavily than desired on “time-based” forward guidance, focusing on when interest rates are likely to rise rather than under what circumstances. We argue that, except under unusual circumstances, this is an imprudent strategy, as it mutes the effect of macroeconomic news on interest rates and unnecessarily places restrictions on future Federal Reserve action when new information arrives. We argue that the Federal Reserve can improve communication in the current environment by moving away from time-based forward guidance, clarifying how interest rates are likely to change given new information, and providing more information in the Summary of Economic Projections.
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TL;DR: The authors explored the effectiveness and balance of benefits and costs of so-called "unconventional" monetary policy measures extensively implemented in the wake of the financial crisis: balance sheet policies (commonly termed "quantitative easing"), forward guidance and negative policy rates.
Abstract: We explore the effectiveness and balance of benefits and costs of so-called "unconventional" monetary policy measures extensively implemented in the wake of the financial crisis: balance sheet policies (commonly termed "quantitative easing"), forward guidance and negative policy rates. Our objective is to provide the reader with a helpful entry point to the burgeoning empirical literature and with a specific perspective on the complex issues involved. We reach three main conclusions: there is ample evidence that, to varying degrees, these measures have succeeded in influencing financial conditions even though their ultimate impact on output and inflation is harder to pin down; the balance of the benefits and costs is likely to deteriorate over time; and the measures are generally best regarded as exceptional, for use in very specific circumstances. Whether this will turn out to be the case, however, is doubtful at best and depends on more fundamental features of monetary policy frameworks. In the paper, we also provide a critique of prevailing analyses of "helicopter money" and explore in more depth the role of negative nominal interest rates in our fundamentally monetary economies, highlighting some risks.
145 citations
Cites background from "Language after liftoff: Fed communi..."
...See Woodford (2003, Chapter 4) for a discussion of how consumption depends on the expected future path of real interest rates in textbook New Keynesian models....
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...See Cliffe (2016)....
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...See, for instance, Borio (2014a) and BIS (2016a)....
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...14 See Feroli et al (2016) for a discussion of how forward guidance, especially if calendar-based, may hurt a central bank’s reputation and credibility if it is perceived as a commitment to a certain course of action....
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TL;DR: This paper found that central banks in crisis countries are more likely to have resorted to new policies, to have had discussions about mandates, and to have communicated more than non-crisis countries.
Abstract: We ask whether recent changes in monetary policy due to the financial crisis will be temporary or permanent. We present evidence from two surveys — one of central bank governors, the other of academic specialists. We find that central banks in crisis countries are more likely to have resorted to new policies, to have had discussions about mandates, and to have communicated more. But the thinking has changed more broadly — for instance, central banks in non-crisis countries also report having implemented macro-prudential measures. Overall, we expect central banks in the future to have broader mandates, use macro-prudential tools more widely, and communicate more actively than before the crisis. While there is no consensus yet about the usefulness of unconventional monetary policies, we expect most of them will remain in central banks’ toolkits, as governors who gain experience with a particular tool are more likely to assess that tool positively. Finally, the relationship between central banks and their governments might well have changed, with central banks “crossing the line” more often than in the past.
75 citations
TL;DR: In this paper, the spillover effects of US uncertainty shocks are studied in a panel VAR of fifteen emerging market economies (EMEs) and they find that a US uncertainty shock negatively affects EME stock prices and exchange rates, raises EME country spreads, and decreases capital inflows into them.
Abstract: Spillover effects of US uncertainty shocks are studied in a panel VAR of fifteen emerging market economies (EMEs). A US uncertainty shock negatively affects EME stock prices and exchange rates, raises EME country spreads, and decreases capital inflows into them. It decreases EME output and consumer prices while increasing net exports. Negative effects on output and asset prices are weaker, but effects on external balance stronger, for Latin American EMEs. We attribute such heterogeneity to differential EME monetary policy response to US uncertainty shocks. Analysis of central bank minutes shows Latin American EMEs pay less attention to smoothing capital flows.
73 citations
TL;DR: In this paper, the authors study how monetary policy communication should and has worked under unconventional times and show that announcements of asset purchase programmes have lowered market uncertainty, particularly when accompanied by a contextual release of implementation details such as the envisaged size of the programme.
Abstract: Monetary policy communication is particularly important during unconventional times, because high uncertainty about the economy, the introduction of new policy tools and possible limits to the central bank’s toolkit could hamper the predictability of policy actions. We study how monetary policy communication should and has worked under such circumstances. Our main results relate to announcements of asset purchase programmes and the use of forward guidance. We show that announcements of asset purchase programmes have lowered market uncertainty, particularly when accompanied by a contextual release of implementation details such as the envisaged size of the programme. We also show that forward guidance reduces uncertainty more effectively when it is state‐contingent or when it provides guidance about a long horizon than when it is open‐ended or covers only a short horizon, and that the credibility of forward guidance is strengthened if the central bank also has embarked on an asset purchase programme.
73 citations
Cites methods from "Language after liftoff: Fed communi..."
...This has been documented by Swanson and Williams (2014a) and Feroli et al. (2016) for the United States, and by Swanson and Williams (2014b) for the UK and Germany....
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Posted Content•
TL;DR: In this paper, the spillover effects of US uncertainty fluctuations using panel data from fifteen emerging market economies (EMEs) were studied, showing that a US uncertainty shock negatively affects EME stock prices and exchange rates, raises EME country spreads, and leads to capital outflows from them.
Abstract: We study spillover effects of US uncertainty fluctuations using panel data from fifteen emerging market economies (EMEs). A US uncertainty shock negatively affects EME stock prices and exchange rates, raises EME country spreads, and leads to capital outflows from them. Moreover, it decreases EME output, while increasing their consumer prices and net exports. The negative effects on output, exchange rates, and stock prices are weaker, but the effects on capital and trade flows stronger, for South American countries compared to other EMEs. We present a model of a small open economy that faces an external shock to interpret our findings.
69 citations
References
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TL;DR: In this article, the authors examine how recent econometric policy evaluation research on monetary policy rules can be applied in a practical policymaking environment, and the discussion centers around a hypothetical but representative policy rule much like that advocated in recent research.
Abstract: This paper examines how recent econometric policy evaluation research on monetary policy rules can be applied in a practical policymaking environment. According to this research, good policy rules typically call for changes in the federal funds rate in response to changes in the price level or changes in real income. An objective of the paper is to preserve the concept of such a policy rule in a policy environment where it is practically impossible to follow mechanically any particular algebraic formula that describes the policy rule. The discussion centers around a hypothetical but representative policy rule much like that advocated in recent research. This rule closely approximates Federal Reserve policy during the past several years. Two case studies-German unification and the 1990 oil-price shock-that had a bearing on the operation of monetary policy in recent years are used to illustrate how such a policy rule might work in practice.
8,414 citations
TL;DR: In this paper, it was shown that discretionary policy does not result in the social objective function being maximized, and that there is no way control theory can be made applicable to economic planning when expectations are rational.
Abstract: Even if there is an agreed-upon, fixed social objective function and policymakers know the timing and magnitude of the effects of their actions, discretionary policy, namely, the selection of that decision which is best, given the current situation and a correct evaluation of the end-of-period position, does not result in the social objective function being maximized. The reason for this apparent paradox is that economic planning is not a game against nature but, rather, a game against rational economic agents. We conclude that there is no way control theory can be made applicable to economic planning when expectations are rational.
7,652 citations
Book•
01 Jan 2003
TL;DR: Woodford as discussed by the authors proposes a rule-based approach to monetary policy suitable for a world of instant communications and ever more efficient financial markets, arguing that effective monetary policy requires that central banks construct a conscious and articulate account of what they are doing.
Abstract: With the collapse of the Bretton Woods system, any pretense of a connection of the world's currencies to any real commodity has been abandoned. Yet since the 1980s, most central banks have abandoned money-growth targets as practical guidelines for monetary policy as well. How then can pure "fiat" currencies be managed so as to create confidence in the stability of national units of account? Interest and Prices seeks to provide theoretical foundations for a rule-based approach to monetary policy suitable for a world of instant communications and ever more efficient financial markets. In such a world, effective monetary policy requires that central banks construct a conscious and articulate account of what they are doing. Michael Woodford reexamines the foundations of monetary economics, and shows how interest-rate policy can be used to achieve an inflation target in the absence of either commodity backing or control of a monetary aggregate. The book further shows how the tools of modern macroeconomic theory can be used to design an optimal inflation-targeting regime--one that balances stabilization goals with the pursuit of price stability in a way that is grounded in an explicit welfare analysis, and that takes account of the "New Classical" critique of traditional policy evaluation exercises. It thus argues that rule-based policymaking need not mean adherence to a rigid framework unrelated to stabilization objectives for the sake of credibility, while at the same time showing the advantages of rule-based over purely discretionary policymaking.
4,938 citations
Book•
01 Jan 2003TL;DR: Woodford as mentioned in this paper proposes a rule-based approach to monetary policy suitable for a world of instant communications and ever more efficient financial markets, arguing that effective monetary policy requires that central banks construct a conscious and articulate account of what they are doing.
Abstract: With the collapse of the Bretton Woods system, any pretense of a connection of the world's currencies to any real commodity has been abandoned. Yet since the 1980s, most central banks have abandoned money-growth targets as practical guidelines for monetary policy as well. How then can pure "fiat" currencies be managed so as to create confidence in the stability of national units of account? Interest and Prices seeks to provide theoretical foundations for a rule-based approach to monetary policy suitable for a world of instant communications and ever more efficient financial markets. In such a world, effective monetary policy requires that central banks construct a conscious and articulate account of what they are doing. Michael Woodford reexamines the foundations of monetary economics, and shows how interest-rate policy can be used to achieve an inflation target in the absence of either commodity backing or control of a monetary aggregate. The book further shows how the tools of modern macroeconomic theory can be used to design an optimal inflation-targeting regime--one that balances stabilization goals with the pursuit of price stability in a way that is grounded in an explicit welfare analysis, and that takes account of the "New Classical" critique of traditional policy evaluation exercises. It thus argues that rule-based policymaking need not mean adherence to a rigid framework unrelated to stabilization objectives for the sake of credibility, while at the same time showing the advantages of rule-based over purely discretionary policymaking.
4,823 citations
TL;DR: In this article, a review of the recent literature on monetary policy rules is presented, and the authors exposit the monetary policy design problem within a simple baseline theoretical framework and consider the implications of adding various real word complications.
Abstract: This paper reviews the recent literature on monetary policy rules. To organize the discussion, we exposit the monetary policy design problem within a simple baseline theoretical framework. We then consider the implications of adding various real word complications. We concentrate on developing results that are robust across a reasonable variety of competing macroeconomic frameworks. Among other things, we show that the optimal policy implicitly incorporates inflation targeting. We also characterize the gains from making credible commitments to fight inflation and consider the implications of frictions such as imperfect information and model uncertainty. Finally, we assess how proposed simple rules, such as the Taylor rule, square with the principles for optimal policy that we describe. We use this same metric to evaluate the recent course of U.S. monetary policy.
4,540 citations