When Central Bankers' Words Spoke Louder than Their Action

With more than half the world’s population under stay-at-home mandates by the end of March 2020, many businesses were forced to close and economic activity plunged. Stock markets fell, and some investors rushed to cash out. In response, central banks enacted expansionary policies to bolster aggregate demand and restore market stability. Between 2020 and 2021, the Federal Reserve increased its asset holdings by 22 percent of GDP; the European Central Bank increased its holdings by 33 percent. Both purchased government securities primarily, but they also bought corporate bonds and asset-backed instruments.

In Whatever-It-Takes Policymaking during the Pandemic (NBER Working Paper 32115), Kathryn M.E. Dominguez and Andrea Foschi examine how interest rates and exchange rates responded to the monetary policy announcements of 23 central banks between March 2020 and December 2021. The 23 central banks made 166 asset-purchase announcements during the study period, 28 percent of which were coded as open ended. Policy announcements that suggested a willingness to do whatever it took to restore market confidence had significantly greater impact than announcements that included an explicit limit on the scale of asset purchases.

When the COVID-19 outbreak depressed financial markets, the most effective central banks were those that convinced market participants that they would do whatever was necessary to restore stability.

The researchers find that on average, whatever-it-takes announcements lowered 10-year bond yields by 47 basis points more than size-limited announcements. Further, open-ended announcements had a sizable effect on the yields of longer maturities — maturities that go well beyond the time by which asset purchases would have stopped, suggesting that the announcements affected long-run expectations. When central banks made several whatever-it-takes announcements, the later ones had a smaller effect, on average, than the first one.

“[T]he real power of whatever-it-takes policy lies largely in its shock-and-awe effect when it is first announced,” the researchers write. They stress that their findings are about the impact of the announcements, not subsequent purchases. The size of asset purchases often turned out to be much smaller than the markets had initially anticipated.

The relative impact of open-ended announcements was less pronounced for bonds of shorter duration, for which interest rates were already near zero in many advanced economies. Whatever-it-takes policy announcements were particularly effective at lowering rates in emerging markets, where fewer central banks had employed major asset purchase programs in previous recessions, making their announcements more of a surprise.

Exchange rate responses to central bank announcements varied. Traditionally, a nation’s currency depreciates when the central bank lowers interest rates. However, during times of financial turmoil, safety concerns can feature prominently in investor decisions. When some advanced economies’ central banks announced asset purchases, their currencies appreciated due to the reinforced perception of safety. In emerging economies, however, open-ended announcements resulted in significant depreciation.

“Whatever-it-takes announcements set a high bar, potentially leading to ever escalating market expectations for large-scale intervention,” the researchers conclude. “It does not follow that central banks can rely on whatever-it-takes policy in future crises.”

— Steve Maas