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When Will the Fed End Its Zero Rate Policy?

Federal Reserve Bank of San Francisco - When Will the Fed End Its Zero Rate Policy? by Jens Christensen “U.S. Treasury yields and other interest rates increased in the months leading up to the Federal Reserve’s December 2013 decision to cut back its large-scale bond purchases. This increase in rates probably at least partly reflected changes in what bond investors expected regarding future monetary policy. Recent research on this episode tentatively suggests that investors moved earlier the date when they believed the Fed would exit its zero interest rate policy, even though Fed policymakers made few changes in their projections of appropriate monetary policy.

“The severe shock of the 2007–08 financial crisis prompted the Federal Reserve to quickly lower its target for its primary policy rate, the overnight federal funds rate, near to zero, where it has remained since. Despite this highly stimulatory stance of conventional monetary policy, the economic recovery has been sluggish and inflation has been low. For that reason, the Federal Open Market Committee (FOMC), the Fed’s policy body, has provided additional monetary stimulus by using unconventional measures to push down longer-term interest rates. One element of this unconventional policy has been large-scale asset purchases (LSAPs). Another has been public guidance about how long the FOMC expects to keep its federal funds rate target exceptionally low. The effect of this forward guidance depends on how financial market participants interpret FOMC communications, in particular when they expect the Fed to exit from its near-zero rate policy, a shift often called “liftoff” (see Bauer and Rudebusch 2013). This Economic Letter examines recent research estimating when bond investors expect liftoff to take place (see Christensen 2013). This research suggests that bond investor expectations for the date of exit have moved forward notably in recent months, probably because they anticipated the FOMC’s decision at its December 2013 meeting to cut back large-scale asset purchases. This research suggests that market participants expect the FOMC to start raising rates in the spring of 2015, but the exact timing is highly uncertain.”

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