Evaluating the Effects of Forward Guidance and Large-scale Asset Purchases

Between December 2008 and December 2015, the Federal Open Market Committee (FOMC) of the Federal Reserve Bank (the Fed) resorted to two unconventional monetary policies, forward guidance and large-scale asset purchases (LSAP), to provide stimulus to the economy.  

 Although the two policies are usually announced together, they affect the yield curve and the macroeconomy through different channels. When the Fed provides forward guidance—that is, communicating to the public about the likely course of monetary policy in the near future—individuals and businesses use this information when making decisions about spending and investment. When the Fed purchases longer-term securities, it offsets the disruption being experienced by private financial intermediaries and supports credit flows from those private intermediaries to firms.  

 In this paper, I propose a novel method to identify and estimate the macroeconomic effects of forward guidance and LSAP for each FOMC announcement. I build a macrofinancial model and show both qualitatively and quantitatively that forward guidance and LSAP have opposite effects on the slope of the yield curve. In particular, forward guidance affects Treasury yields at all maturities, with a peak effect at a maturity of about 20 months. In contrast, LSAP exerts its peak effect on the longest-term maturities but increases the yields of short-term maturities. For this reason, LSAP should always be used in conjunction with forward guidance. 

 I then match the model-predicted change in the yield curve with the observed change in the yield curve in a 30-minute window around Fed announcements to estimate the forward guidance and LSAP policy surprises for each announcement. I then quantify each announcement's influence on the macroeconomy and separate the contributions of forward guidance and LSAP. My estimates imply that LSAP is more important than forward guidance in influencing output and inflation.