Outside the Box: Unconventional Monetary Policy in the Great Recession and Beyond

Abstract

In November 2008, the Federal Reserve faced a deteriorating economy and a financial crisis. The federal funds rate had already been reduced to virtually zero. Thus, the Federal Reserve turned to unconventional monetary policies. Through “quantitative easing,” the Fed announced plans to buy mortgage-backed securities and debt issued by government-sponsored enterprises. Subsequent purchases would eventually lead to a five-fold expansion in the Fed’s balance sheet, from $900 billion to $4.5 trillion, and leave the Fed holding over 20 percent of all mortgage-backed securities and marketable Treasury debt. In addition, Fed policy statements in December 2008 began to include explicit references to the likely path of the federal funds interest rate, a policy that came to be known as “forward guidance.” The Fed ceased its direct asset purchases in late 2014. Starting in October 2017, it has allowed the balance sheet to shrink gradually as existing assets mature. From December 2015 through June 2018, the Fed has raised the federal funds interest rate seven times. Thus, the time is ripe to step back and ask whether the Fed’s unconventional policies had the intended expansionary effects—and by extension, whether the Fed should use them in the future.

Market-Based Monetary Policy Uncertainty

“…To understand the role of changes in monetary policy uncertainty for the financial market effects of unconventional monetary policies, we carry out an event study of major FOMC announcements, following a large and growing literature including, among many others, Gagnon et al (2011), Krishnamurthy and Vissing-Jorgensen (2011) and Bauer and Rudebusch (2014). We choose key events for QE1, QE2, the maturity extension program (MEP), and QE3 among those identified in the existing literature, in particular Bauer and Neely (2014) and Kuttner (2018). For the FG events we follow Raskin (2013) and Swanson (2017).…”

Assessing the Effect of Quantitative Easing on the US Economy from 2008 to 2015 by a Bayesian-VAR Model

“…Based on different methods, certain articles conclude that QE may have depressed the 10-year interest rate by different amounts, ranging from 100 bps to 130 bps for QE1, 20 bps to 40 bps for QE2 and approximately 20 bps for QE3. According to Kuttner (2018) [20], the entire effect of QE would range from 150 bps to 190 bps. This impact is employed in this research by increasing the actual 10-year interest rate by different bps during each QE period to arrive at the potential original level without this QE program and completing conditional forecasts on the changed 10-year interest rate to obtain the resulting counterfactual simulations.…”

“…In the no-policy scenario, the 10-year interest rate is increased by different basis points (bps) to create its counterfactual values at some possible levels when there is no QE. These counterfactual values are based on previous research regarding the effect of QE on the 10-year interest rate, such as Ehlers (2012) [9]; Kuttner (2018 [20]).…”

Complexity of ECB Communication and Financial Market Trading

“…Indeed, in a speech earlier this year at the University of South Africa, Jens Weidmann, President of the Deutsche Bundesbank, argued that 'superpowers were often attributed to central banks as they struggled with the fallout from the financial crisis '. 1 During that time-when interest rates approached the zero lower bound and novel monetary policy instruments like forward guidance emerged-central bank communication became more important (see, e.g., Dell'Ariccia, Rabanal, & Sandri, 2018;Kuttner, 2018).…”