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Working Paper
Should We Be Puzzled by Forward Guidance?
Although a growing literature argues output is too sensitive to future interest rates in standard macroeconomic models, little empirical evidence has been put forth to evaluate this claim. In this paper, we use a range of vector autoregression models to answer the central question of how much output responds to changes in interest rate expectations following a monetary policy shock. Despite distinct identification strategies and sample periods, we find surprising agreement regarding this elasticity across empirical models. We then show that in a standard model of nominal rigidity estimated ...
Working Paper
The dynamic effects of forward guidance shocks
We examine the macroeconomic effcts of forward guidance shocks at the zero lower bound. Empirically, we identify forward guidance shocks using unexpected changes in futures contracts around monetary policy announcements. We then embed these policy shocks in a vector autoregression to trace out their macroeconomic implications. Forward guidance shocks that lower expected future policy rates lead to moderate increases in economic activity and inflation. After examining forward guidance shocks in the data, we show that a standard model of nominal price rigidity can reproduce our empirical ...
Journal Article
How Many Reserves Does the Federal Reserve Need to Supply?
The level of reserves the Federal Reserve needs to supply depends on the spread between the federal funds rate and the IOR rate. If policymakers choose to operate with a near-zero federal funds-IOR spread, then reserve balances of $1.5 trillion may be required to implement monetary policy. However, if policymakers opt for a higher federal funds-IOR spread, then reserve balances of about $1.1 trillion may suffice.
Journal Article
Policymakers Have Options for Additional Accommodation: Forward Guidance and Yield Curve Control
With the federal funds rate near zero, policymakers are evaluating options for providing additional monetary policy accommodation, including a tool known as yield curve control. We find that despite low nominal Treasury yields, some scope for additional accommodation remains should policymakers deem it appropriate. However, we argue that forward guidance about future interest rates could deliver much, though not all, of the accommodation of yield curve control.
Journal Article
The Evolving Role of the Fed’s Balance Sheet: Effects and Challenges
In this article, Chaitri Gulati and A. Lee Smith present evidence that the Federal Reserve’s expanded balance sheet, with a large portfolio of long-duration assets, has provided a significant amount of policy accommodation in recent years, depressing long-term interest rates by about 1.6 percentage points as of early 2022. They also argue that the FOMC’s plan to remove this accommodation through the passive runoff of maturing securities may prove challenging. They project that the downward pressure the balance sheet is currently placing on longer-term interest rates will only gradually ...
Journal Article
Assessing Market Conditions ahead of Quantitative Tightening
Quantitative tightening (QT)—the reduction in the Federal Reserve’s balance sheet—will transfer a significant amount of Treasury and agency mortgage-backed securities to investors. This transfer will be larger than the first endeavor with QT in 2017 and will occur at a time when financial markets are strained, suggesting this round of QT has the potential to be more disruptive compared with the benign start to the 2017 runoff.
Journal Article
Has forward guidance been effective?
A. Lee Smith and Thealexa Becker compare forward guidance announcements with changes in the effective federal funds rate and find the two policy measures have had similar macroeconomic effects.
Working Paper
The Term Structure of Monetary Policy Uncertainty
This paper studies the transmission of Federal Reserve communication to financial markets and the economy using new measures of the term structure of policy rate uncertainty. Movements in the term structure of interest rate uncertainty around FOMC announcements cannot be summarized by a single measure but instead are two dimensional. We characterize these two dimensions as the level and slope factors of the term structure of interest rate uncertainty. These two monetary policy uncertainty factors significantly help to explain changes in Treasury yields and forward real interest rates around ...
Journal Article
Evaluating Quantitative Easing: The Importance of Accounting for Forward Guidance
During the COVID-19 pandemic crisis, policymakers used large-scale asset purchases (LSAPs) along with forward guidance about the future path of the federal funds rate to help stabilize financial markets. However, policymakers and economists have yet to reach a consensus on the efficacy of LSAPs in providing accommodation and improving macroeconomic outcomes. Because announced changes in LSAPs often coincide with changes in forward guidance, the market responses to these two tools can be difficult to disentangle and each tool’s efficacy challenging to evaluate.Brent Bundick and A. Lee Smith ...
Journal Article
Why Are Americans Saving So Much of Their Income?
For much of 2020, Americans have saved a greater share of their income than ever before. This increase in savings appears to be predominantly driven by precautionary motives. Therefore, consumers may be reluctant to draw down these savings in the future to support spending.