Hardly ground breaking stuff and misses the connection between previous interest rate cuts and the credibility of later promises to keep interest rates low over a "considerable period".
I will get the reference but economists at the Fed and elsewhere were well aware that as nominal interest rates approached zero and the real interest rate threatened to cross the horizontal axis, deminising returns would set in.
That is, the stimulative difference between a reduction in the rate from 6 to 5.5% is likely to be greater than that between 2 and 1.5% because at the former initial level financing costs maybe a large chunk of the total cost of building new plant and facilities whereas as the latter rates (rates approaching zero) servicing costs become less and less of a consideration and other factors come into play on both the supply and demand sides of the planning equation.
On the supply side the key element becomes a question of the stability of the rate, i.e., if the rate is uncertain over the medium term than any planning has to be based on some risk calculation of what the financing costs are likely to be 5 years from now.
The Feds promise to keep rates low for a "considerable period" of time allows for longer term planning based on the assumption lower medium term rates. The study concludes this as well: "The statements had a direct effect on policy expectations, causing investors to push back the expected onset and pace of policy tightening."
Where the study is flawed is that it implicitly presupposes that if the fed made the promise prior to their (the feds) series of rate cuts that it would have had or could have had the same effect. Imagine a statement from the fed that read: "we intend to lower rates and keep them lower for a considerable period." In absence of previous rate cuts markets would wait to see if (a) the fed actually cut rates, and (b); did so during bad as well as good times. That is the fed would have to show a commitment to low stable rates in the face of different macroeconomic environments.
Thus to argue that statements about the Feds intentions had a more profound effect than rate cuts is misleading because, as I argued above, the former relies on the latter for credibility.
Travis
> WSJ.com - September 16, 2004
>
> Fed Study Calls Strategy
> Based on Promise a Success
> Economy Benefited From Pledge to Keep
> Rates Low for 'Considerable Period'
>
> By JOSEPH REBELLO
>
> WASHINGTON -- The unusual strategy adopted by the Federal Reserve in the
> summer of 2003 for stoking the U.S. economy without cutting interest rates
> was a clear success, researchers at the U.S. central bank have concluded
> in a new study.
>
> The study, led by Fed Governor Ben Bernanke, says the central bank managed
> to exert powerful effects on longer-term interest rates merely by
> promising to keep the key short-term federal funds rate low for a
> "considerable period." Those influences were at least five times stronger
> than the average effect of actual interest-rate changes from 1991 onward.