March 22, 2012 / 5:13 PM / in 6 years

Fed's words do influence longer-term rates: paper

WASHINGTON (Reuters) - The Federal Reserve’s verbal clues on the future path of interest rates are effective at lowering borrowing costs, according to a paper co-authored by a top central bank official.

Based on data going back to the mid-1990s, Charles Evans, president of the Chicago Fed, and three other economists, found that markets do indeed listen when the Fed speaks, according to the research, which is to be presented at a Brookings Institution conference on Thursday.

The paper from Evans, a vocal policy dove, lends support to the Fed’s decision earlier this year to begin publishing policymakers’ own forecasts for the path of rates, and to clearly state that the Federal Open Market Committee expects rates to remain near zero until at least late 2014.

“It seems possible for the FOMC to change longer term interest rates out of its control by promising to persistently lower the shorter term rates within its control,” the paper says.

A recent selloff in U.S. Treasuries has made it harder to support the argument that the Fed is in full control of long-term interest rates, and has raised some concern that a deeper reversal could be at hand following a prolonged period of rock-bottom rates.

Bond prices move inversely to rates. Rates on the 10-year Treasury note have risen about 0.3 percentage point in the last two weeks.

But the Brookings conference paper, co-authored by Jeffrey Campbell, Jonas Fisher and Alejandro Justiniano, indicates the Fed could again assert itself on the Treasury yield curve if it felt the need.

“Forward guidance in monetary policy statements has had a significant effect on yields of Treasury notes and corporate bonds since the onset of the financial crisis,” the authors wrote.

The economists distinguish between guidance that merely reflects prevailing expectations and policy clues that shift the public’s assessment on the path of rates.

Evans has advocated even more aggressive action than the Fed has taken. In his view, the central bank could allow inflation to rise above its 2 percent target for a period in order to bring down a persistently high jobless rate from the current 8.3 percent.

In response to the worst recession since the Great Depression, the Fed not only chopped official interest rates down to zero but also purchased some $2.3 trillion in Treasury and mortgage-linked bonds in an effort to keep down long-term interest rates.

Editing by Leslie Adler

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