Magazine article Economic Trends

Policy Innovations at the Zero Lower Bound

Magazine article Economic Trends

Policy Innovations at the Zero Lower Bound

Article excerpt

12.01.11

The late summer and early fall bore witness to two new innovations in monetary policy.

The first was at the August Federal Open Market Committee (FOMC) meeting, when the Committee introduced a change to the statement released after meetings, which altered the projected path of the federal funds rate target. The Committee announced that it "currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013."

The second came in September, when the Committee opted to begin selling shorter-term Treasuries from the Fed's portfolio and use the proceeds from those sales to purchase longer-term Treasury securities. According to the statement, "this should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative."

Both of these innovative moves were intended to adjust interest rates, one through communications and one through balance sheet manipulations. Here's a quick look at how they did and at what some of the consequences could be.

The new language introduced in August is clearly a conditional statement. Whether the federal funds rate stays "exceptionally low" until mid-2013 depends on the economy progressing as the FOMC thinks it will. The August communication strategy, as we've highlighted before, was extremely effective at lowering expected future interest rates. One way of seeing how markets interpreted this statement is by looking at a type of derivative called a federal funds rate future contract. The contract allows banks to borrow interbank (federal) funds at a specified rate at some date in the future. Implied interest rates from these contracts declined dramatically after the August statement, incorporating the expectation that the federal funds rate would remain low until the middle of 2013.

[GRAPHIC OMITTED]

[GRAPHIC OMITTED]

[GRAPHIC OMITTED]

The announcement of September's new policy, dubbed Operation Twist, was also successful at lowering long-term interest rates. A simple chart of some longer-maturity Treasury yields shows that there were significant declines following the release of the Committees statement. Yields on 30-year Treasury securities fell 17 basis points to 3.03 percent, and 10-year Treasury yields dropped 23 basis points in the two days following the meeting. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.