For Federal Reserve officials, the sword may in fact be mightier than the pen.
That’s the finding of a new paper from Eric Swanson, a professor at the University of California, Irvine, and a former researcher at the San Francisco Fed.
Swanson compared the effects on financial conditions of the central bank’s bond-buying programs during and after the Great Recession, also known as quantitative easing, or QE, with the effects of the Fed’s forward guidance, or their verbal nods to what officials might do in the future.
Swanson found that while big announcements from the Fed might have a temporary effect on short-term yields, the impact of bond buys, which totaled in the trillions and quintupled the Fed’s balance sheet to around $US4.5 trillion in assets, was deeper and longer lasting.
Swanson wrote, “I find that both forward guidance and large-scale asset purchases (LSAPs) had substantial and highly statistically significant effects on medium-term Treasury yields, stock prices, and exchange rates, comparable in magnitude to the effects of the federal funds rate before,” interest rates were at zero, starting in December 2008.
“Forward guidance was more effective than large-scale asset purchases at moving short-term Treasury yields, while [bond buys] were more effective than forward guidance and the federal funds rate at moving longer-term Treasury yields, corporate bond yields, and interest rate uncertainty,” Swanson wrote.
Even though Fed-talk helped ease short-term interest rates, Swanson found that it tended to wear off pretty quickly, while QE’s effects were longer-lasting.
“However, the effects of forward guidance were not very persistent, with a half-life of 1-4 months. The effects of LSAPs seem to be more persistent. I conclude that, overall in terms of these criteria, LSAPs were a more effective policy tool than forward guidance” with official rates at zero.
Swanson’s view stands in contrast to that of his former boss, San Francisco Fed President John Williams, who has been sceptical of additional monetary easing and suggested that forward guidance could be just as powerful.
Swanson’s research also offers a hint of why some top Fed officials recently argued the central bank is bound to end up buying bonds en masse again when the next recession comes around.
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