Balas: For QE, Words Are More Important Than Actions
By signaling an intention to keep low interest rates in place for a longer period, the Fed reduces this premium that investors demand for holding a longer-term bond. That, it seems, played a greater role in reducing longer-term interest rates than the bond-buying program itself did. The researchers determined that the forward guidance reduced this risk premium by a median of 0.12 percentage point, depending on the maturity of the bond.
Of course, the Fed's alternatives have been limited, as the fed funds rate can't be lowered any further than the current levels of near zero. If the Fed could have reduced the fed funds rate by 0.25 percentage point, the economic effects would have been greater. In fact, according to the researchers, a quarter-point reduction in the fed funds rate would have increased GDP by 0.26 percentage point -- about double the effects of QE2 and forward guidance -- and added about 0.04 percentage point to inflation.
So, as the Fed deliberates how long it should continue the current round of bond purchases, there will likely be some consideration as to the efficacy of earlier rounds of QE. Some Fed members are becoming more concerned about potential risks and distortions the bond-buying program may entail, as well as about the eventual exit strategy and how to communicate when the end of the current bond-buying program might come -- but without spooking the markets too much.
It's likely that, given the proportional benefits to GDP provided by communication efforts, rather than by the bond-buying program itself, the Fed will need to tune its message carefully in order to avoid a counter-effective adverse market reaction. It does seem, though, that an eventual end to QE will be coupled by a redoubling of efforts to stress that an end to the bond-purchase program does not mean the fed funds rate will be hiked anytime soon. That may yield at least some intended benefits.Lastly, though, there probably isn't much hurry to end the bond-purchase program at the next Federal Open Market Committee meeting, slated for September. That's because the risks to ending it too soon may be greater than the risks to ending it at a later date. Tuesday, Dennis Lockhart of the Atlanta Fed gave a speech in which he said that, right now, the Fed will likely wait a little longer before it announces the end of QE. Lockhart's views are often more moderate and close to the Fed's consensus -- though he is not a voter on the committee this year.
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