Can Central Banks Target Bond Prices?

This paper addresses the possible role of bond prices as operating or intermediate targets for monetary policy. The paper begins with a brief review of the mechanisms through which a central bank could, in theory, influence long-term interest rates, and continues with a brief narrative overview of debt management policies in the U.S., tracing their effects on the maturity distribution of outstanding publicly-held Treasury debt and the composition of the assets held by the Federal Reserve System. The empirical section presents new econometric evidence on the effects of these policies on expected excess holding returns (“term premia”), demonstrating that changes in the Fed’s holdings of long-term securities have had statistically significant and economically meaningful effects on the term premia associated with Treasury securities with maturities in the two- to five-year range.

Low Interest Rates and Housing Bubbles: Still No Smoking Gun

This paper revisits the relationship between interest rates and house prices. Surveying a number of recent studies and bringing to bear some new evidence on the question, this paper argues that in the data, the impact of interest rates on house prices appears to be quite modest. Specifically, the estimated effects are uniformly smaller than those implied by the conventional user cost theory of house prices, and they are too small to explain the previous decadeÂ’s real estate boom in the U.S. and elsewhere. However in some countries, there does appear to have been a link between the rapid expansion of the monetary base and growth in house prices and housing credit.

Monetary Policy and Asset Price Volatility: Should We Refill the Bernanke-Gertler Prescription?

Bernanke and Gertler’s influential 1999 article “Asset Price Bubbles and Monetary Policy” made the case that monetary policy should respond to asset prices only to the extent that they have implications for future inflation. This paper revisits that prescription in light of the 2007–09 financial crisis. After reviewing the Bernanke-Gertler logic, the paper surveys the recent evolution of views on the appropriate policy response to asset price fluctuations, and discusses the conditions under which a proactive policy would be justified. There is almost no discernible relationship between interest rates and stock and property prices across countries during the years leading up to the crisis, however. While a theoretical case could be made to give some weight to financial stability in setting monetary policy, the evidence presented in the paper suggests that incremental interest rate adjustments are unlikely to be effective in restraining excessive asset price appreciation.

Commentary on "Assessing monetary policy effects using daily federal funds futures contracts"

Monetary policy ; Federal funds rate

The role of policy rules in inflation targeting

Monetary policy ; Inflation (Finance) ; Banks and banking, Central

How Flexible Can Inflation Targeting Be and Still Work?

This paper takes up the issue of the flexibility of inflation targeting regimes, with the specific goal of determining whether the monetary policy of the Bank of England, which has a formal inflation target, has been any less flexible than that of the Federal Reserve, which does not have such a target. The empirical analysis uses the speed of inflation forecast convergence, estimated from professional forecastersÂ’ predictions at successive forecast horizons, to gauge the perceived flexibility of the central bankÂ’s response to macroeconomic shocks. Based on this criterion, there is no evidence to suggest that the Bank of EnglandÂ’s inflation target has compelled it to be more aggressive in pursuit of low inflation than the Federal Reserve.

Lost Decade in Translation: Did the US Learn from Japan's Post-Bubble Mistakes?

In 1991, the Japanese economy ended a historic expansion and entered a period of stagnation that has yet to abate. Nine years later, the US economy ended a similarly historic expansion. There were many similarities in the two countries' expansions: asset price bubbles, a real investment boom, easy monetary policy, and improvements in government finances. In the wake of bursting bubbles, the Japanese banking system was insolvent and monetary policy was too tight, problems not evident in the US post-bubble period. But the US has worse fiscal and current account imbalances than Japan had at the same stage in the post-bubble era.

Does talk matter after all? Inflation targeting and central bank behavior

Since 1990, a number of countries have adopted inflation targeting as their declared monetary strategy. Interpretations of the significance of this movement, however, have differed widely. To some, inflation targeting mandates the single-minded, rule-like pursuit of price stability without regard for other policy objectives; to others, inflation targeting represents nothing more than the latest version of cheap talk by central banks unable to sustain monetary commitments. Advocates of inflation targeting, including the adopting central banks themselves, have expressed the view that the efforts at transparency and communication in the inflation targeting framework grant the central bank greater short-run flexibility in pursuit of its long-run inflation goal. This paper assesses whether the talk that inflation targeting central banks engage in matters to central bank behavior, and which interpretation of the strategy is consistent with that assessment. We identify five distinct interpretations of inflation targeting, consistent with various strands of the current literature, and identify those interpretations as movements between various strategies in a conventional model of time-inconsistency in monetary policy. The empirical implications of these interpretations are then compared to the response of central banks to movements in inflation of three countries that adopted inflation targets in the early 1990s: The United Kingdom, Canada, and New Zealand. For all three, the evidence shows a break in the behavior of inflation consistent with a strengthened commitment to price stability. In no case, however, is there evidence that the strategy entails a single-minded pursuit of the inflation target. For the U.K., the results are consistent with the successful implementation the optimal state-contingent rule, thereby combining flexibility and credibility; similarly, New Zealand's improved inflation performance was achieved without a discernable increase in counter-inflationary conservatism. The results for Canada are less clear, perhaps reflecting the broader fiscal and international developments affecting the Canadian economy during this period

What explains the stock market's reaction to Federal Reserve policy?

This paper analyzes the impact of unanticipated changes in the Federal funds target on equity prices, with the aim of both estimating the size of the typical reaction, and understanding the reasons for the market's response. On average over the May 1989 to December 2001 sample, a "typical" unanticipated 25 basis point rate cut has been associated with a 1.3 percent increase in the S&P 500 composite index. The estimated response varies considerably across industries, with the greatest sensitivity observed in cyclical industries like construction, and the smallest in mining and utilities. Very little of the market's reaction can be attributed to policy's effects on the real rate of interest or future dividends, however. Instead, most of the response of the current excess return on equities can be traced to policy's impact on expected future excess returns.