promised until the committee observes sustained economic growth, substantial progress in trimming economic slack, or a period of inflation above a specified floor. in practice, central banks appear to appreciate the importance of influencing market expectations about future policy. for example, in may 2001, with its policy rate virtually at zero, the bank of japan promised that it would keep its policy rate at zero for as long as the economy experienced deflation - - a conditional policy commitment. more recently, the bank of japan has been more explicit about the conditions under which it would begin to raise rates ; for example, it has been specified that a change from deflation to inflation that is perceived to be temporary will not provoke a tightening. 3 in the united states, the august 2003 statement of the federal open market committee that “ policy accommodation can be maintained for a considerable period ” is another example of commitment. the close association of this statement with the committee ’ s expressed concerns about “ unwelcome disinflation ” implied that this commitment was conditioned on the assessment of the economy. the conditional nature of the commitment was sharpened in the committee ’ s december statement, which explicitly linked continuing policy accommodation to the low level of inflation and the slack in resource use. 4 more generally, in recent years central banks have devoted enormous effort to improving their communications and transparency ; a major benefit of such efforts should be a greater ability to align market expectations of policy with the policymaking committee ’ s own intentions. of course, policy commitments can influence future expectations only to the extent that they are credible. various devices might be employed to enhance credibility ; for example, the central bank can make securities purchases or issue financial options that make it quite costly, in financial terms, to renege on its commitments ( clouse et al., 2003 ). an objection to this strategy is that it is not entirely clear why a central bank, which has the power to print money, should be overly concerned about its financial gains and losses. eggertsson and woodford ( 2003 ) point out that a government can more credibly promise to carry out policies that raise prices when ( 1 ) the government debt is large and not indexed to inflation and ( 2 ) the central bank values the reduction in fiscal burden that reflationary policies will bring ( for example, because it may reduce the future level of distortionary taxation ). ultimately, however, the central bank ’ s best strategy for building credibility is to ensure that its deeds match its words, thereby building

trust in its pronouncements. the requirement that deeds match words has the consequence that the shaping of market expectations is not an independent instrument of policy in the long run. ii. altering the composition of the central bank ’ s balance sheet central banks typically hold a variety of assets, and the composition of assets on the central bank ’ s balance sheet offers another potential lever for monetary policy. for example, the federal reserve participates in all segments of the treasury market, with most of its current asset holdings of about $ 670 billion distributed among treasury securities with maturities ranging from four weeks to thirty years. over the past fifty years, the average maturity of the federal reserve system ’ s holdings of treasury debt has varied considerably within a range from one to four years. as an important participant in the treasury market, the federal reserve might be able to influence term premiums, and thus overall yields, by shifting the composition of its holdings, say from shorter - to longer - dated securities. in simple terms, if the liquidity or risk characteristics of securities differ, so that investors do not treat all securities as perfect substitutes, then changes in relative demands by a large purchaser have the potential to alter relative security prices. ( the same logic might lead the central bank to consider purchasing assets other than treasury securities, such as corporate bonds or stocks or for a recent appraisal of monetary policy options in japan, see bernanke ( 2003 ). 2003 fomc statements and minutes. foreign government bonds. the federal reserve is currently authorized to purchase some foreign government bonds but not most private - sector assets, such as corporate bonds or stocks. ) perhaps the most extreme example of a policy keyed to the composition of the central bank ’ s balance sheet is an announced ceiling on some longer - term yield below the prevailing rate. this policy entails ( in principle ) an unlimited commitment to purchase the targeted security at the announced price. ( to keep the overall size of its balance sheet unchanged, the central bank would have to sell other securities in an amount equal to the purchases of the targeted security. ) obviously, such a policy would signal strong dissatisfaction on the part of the policymaking committee with current market expectations of future policy rates. whether policies based on manipulating the composition of the central bank balance sheet can be effective is a contentious issue. the limited empirical evidence generally suggests that the degree of imperfect substitutability within broad asset classes, such as treasury securities, is not great, so that changes in