Fed Zero-Rate Hasn’t Hobbled Policy, Regional Bank Says

The Federal Reserve’s cut in the main interest rate to zero hasn’t impaired its ability to bring down borrowing costs as much as is perceived, according to a regional Fed bank.

“To the extent that the Fed can affect these longer-term interest rates through forward guidance and large-scale purchases of longer-term bonds, the zero lower bound appears not to have constrained monetary policy as much as is sometimes believed,” Eric Swanson, a senior research adviser at the San Francisco Fed, said in a research note released today.

U.S. central bankers have deployed unprecedented tools to bolster the economy after cutting the benchmark interest rate almost to zero, or the so-called zero-lower bound, in December 2008.

The Fed has expanded its balance sheet to a record $3.73 trillion and provided more guidance on the future of policy. Policy makers surprised financial markets on Sept. 18 by refraining from tapering $85 billion in monthly bond buying.

The Fed’s use of forward guidance and large-scale asset purchases on several occasions between 2009 and 2012 pushed down medium- and longer-term Treasury yields by as much as 0.2 percentage point, Swanson said.

“In normal times, it would take a federal funds rate cut of about 0.75 to 1 percentage point to produce a decline in medium- and longer-term yields of this magnitude,” he said. “There was still significant room for monetary policy to affect yields and the economy through the end of 2012.”

The research is based on a paper co-written by Swanson and San Francisco Fed President John Williams. They assessed the impact of Fed policy by measuring the sensitivity of Treasury yields to economic announcements, such as the monthly jobs report or figures on inflation.

Three-month Treasuries were no longer responsive to news from the spring of 2009, while 10-year Treasuries were largely unaffected by the zero bound even in late 2012, Swanson said.

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