The Zero Lower Bound, Forward Guidance and How Markets Respond to News

12 Pages Posted: 7 Mar 2019

See all articles by Richhild Moessner

Richhild Moessner

Bank for International Settlements (BIS)

Phurichai Rungcharoenkitkul

Bank for International Settlements (BIS) - Monetary and Economic Department

Date Written: March 5, 2019

Abstract

Short-term market interest rates seem to have been less responsive to economic news in the post-crisis period. We evaluate two potential reasons: forward guidance and the constraint on monetary policy imposed by the zero lower bound (ZLB). We quantify how the ZLB has dampened market reactions to news in the United States, using estimates of the probability of hitting the ZLB derived from overnight index swap rates. For short maturities, variations in the ZLB's probability are sufficient to account for the fall in the sensitivity of market interest rates while the ZLB was binding. However, since it was precisely at the ZLB that forward guidance was most actively used, its role cannot be ruled out. But even after the policy rate rose, significantly reducing the ZLB's probability, the market's response to news continued to be more muted for shorter-maturity bonds and some risky assets. This suggests that other mechanisms also played a part, including forward guidance about gradual policy rate normalisation.

JEL Classification: E52, E58

Suggested Citation

Moessner, Richhild and Rungcharoenkitkul, Phurichai, The Zero Lower Bound, Forward Guidance and How Markets Respond to News (March 5, 2019). BIS Quarterly Review, March 2019, Available at SSRN: https://ssrn.com/abstract=3348193

Richhild Moessner (Contact Author)

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

Phurichai Rungcharoenkitkul

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

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