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Abstract: Between August 2011 and December 2012 the Federal Open Market Committee (FOMC) used date-based forward guidance to help stimulate the U.S. economy and promote its objectives of maximum employment and price stability. Some have argued that the formulation of the guidance that the FOMC used may have reduced interest rates primarily by signaling a weak economic outlook rather than by signaling a more accommodative stance of monetary policy. I examine the impact of the date-based guidance, with the principal goal of discerning the extent to which it altered investors' views of the FOMC's policy reaction function. I show that one seemingly straightforward way to address this question—using estimates of the sensitivity of money market futures rates to macroeconomic data surprises—is confounded by the zero lower bound on nominal interest rates, a point that has more general implications for the analysis of the effects of monetary policy at the zero bound. I demonstrate that the problem can be overcome using distributions of investors' short-term interest rate expectations derived from interest rate options. Using PDFs constructed from these options, along with survey measures of macroeconomic surprises, I find the date-based guidance led to a statistically significant and economically meaningful change in investors' perceptions of the FOMC's reaction function. This finding is robust to various regression specifications and the use of alternative options contracts and PDF fitting methodologies.

Keywords: Monetary policy, zero lower bound, forward guidance, economic surprises

Full paper (866 KB PDF)