The Federal Reserve's asset purchase plan's success in stimulating the economy seems to be tied to Fed assurance that interest rates would remain low, according to an economic letter from the Federal Reserve Bank of San Francisco, released Monday.

"The Federal Reserve's large-scale purchases of long-term Treasury securities most likely provided a moderate boost to economic growth and inflation," the letter said. "Importantly, the effects appear to depend greatly on the Fed's guidance that short-term interest rates would remain low for an extended period. Indeed, estimates from a macroeconomic model suggest that such interest rate forward guidance probably has greater effects than signals about the amount of assets purchased."

The authors of the report -- Vasco Cúrdia, a senior economist in the Economic Research Department of the San Francisco Fed, and Andrea Ferrero, a senior economist at the New York Fed - estimate that the asset purchasing component of QE2 "added about 0.13 percentage point to real GDP growth in late 2010 and 0.03 percentage point to inflation," but without forward guidance, the benefit would have been "only 0.04 percentage point to GDP growth and 0.02 to inflation."

The authors explained, "Under conventional monetary policy, higher economic growth and inflation would usually lead the Fed to raise interest rates, offsetting the effects of LSAPs. Forward guidance during QE2 mitigated that factor by making it clear that the federal funds rate was not likely to increase."

Quantitative easing is not as effective as a rate cut, the authors say, with "smaller and more uncertain" GDP growth. "In addition, our analysis suggests that communication about when the Fed will begin to raise the federal funds rate from its near-zero level will be more important than signals about the precise timing of the end of QE3, the current round of LSAPs," the authors said.

"Asset purchase programs like QE2 appear to have, at best, moderate effects on economic growth and inflation," the authors said. "Research suggests that the key reason these effects are limited is that bond market segmentation is small. Moreover, the magnitude of LSAP effects depends greatly on expectations for interest rate policy, but those effects are weaker and more uncertain than conventional interest rate policy. This suggests that communication about the beginning of federal funds rate increases will have stronger effects than guidance about the end of asset purchases."

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