If we analyse monetary policy as a threat strategy, then how do we make sure that the threat is credible? According to Nick Rowe, “The Fed needs to communicate its target clearly. And it needs to threaten to do unlimited amounts of QE for an unlimited amount of time until its target is hit. If that threat is communicated clearly, and believed, the actual amount of QE needed will be negative.” In essence, this is a view that a credible threat will cause market expectations to adjust and negate the need for any actual intervention in markets by the central bank.
The current poster-child for this view is the SNB’s maintenance of a floor on the EURCHF exchange rate at 1.20. The market-expectations story argues that because the SNB has credibly committed to maintaining a floor on EURCHF, it will not need to intervene in the markets at all (See Evan Soltas here and here, Scott Sumner, Matthew Yglesias and Timothy Lee). And indeed the SNB did not need to intervene at all…..that is, until May, when they were required to intervene to the tune of CHF 66 billion within the span of just a month in order to defend the floor from euro-crisis induced safe-haven flows.
Even when the central bank wants to hit a target as transparent and as liquidly traded as an exchange rate, it seems that actual intervention is needed sooner or later. Therefore when the transmission channel between central bank purchase of assets and the target variable is as blurred as it would be in regimes such as NGDP targeting, it is unlikely that the central bank will get away with just waving the magic wand of market expectations.