JEC Hearing: “The Economic Outlook” with Federal Reserve Chairman Ben Bernanke

Chairman Bernanke is quoted as saying that the "Maturity Extension Program” of $400 billion (Operation Twist 2.0) is expected to have

1. an effect of 20 basis points on the long term interest rate, and
2. equivalent to about a 50 basis points cut in the Federal Funds rate.

When people talks about long term interest rate – it is always unclear to me what they mean specifically – what type of rate (Treasury rate, corporate bond rate, mortgage rate) and what time to maturity (10yr, 20yr, 30yr?)

When I talk about long-term rate in this context, I usually have the 10yr Treasury rate in mind. But it is rarely clear to me what others mean when they talk about "long term interest rate,” and I wish people will be more precise.

This fuzziness in communication reminds me something John Williams addressed in a speech on September 23, 2011, to the Swiss national Bank Research Conference. He was referring to forward guidance as a policy tool and how it might be hampered by communication to and understanding of the public.

A second caveat to the power of forward guidance is that the public may have different expectations of the future course of the economy and monetary policy than the central bank.  The expectations channel is crucial for the effectiveness of optimal forward guidance policy.  If the public has an imperfect understanding of the central bank’s intended policy path, then forward guidance may not work as well as advertised. Therefore, a key challenge for forward guidance is communicating the intended policy path to the public.  Complicating this communication challenge further, optimal forward guidance is inherently state-contingent and depends on
myriad factors and risk assessments.  These are inherently difficult to convey to the public. Moreover, the public and the media tend to gloss over such nuances and take away simple sound bites.

Reference: “The Economic Outlook” with Federal Reserve Chairman Ben Bernanke [US Congress Joint Economic Committee], Unconventional Monetary Policy:  Lessons from the Past Three Years [Federal Reserve Bank of San Francisco]