Quantitative Easing and the ‘New Normal’ in Monetary Policy

Abstract

Interest rates may remain low and fall to their effective lower bound (ELB) often. As a result, quantitative easing (QE), in which central banks expand their balance sheet to lower long‐term interest rates, may complement policy approaches focused on adjustments in short‐term interest rates. Simulation results using a large‐scale model (FRB/US) suggest that QE does not improve economic performance if the steady‐state interest rate is high, confirming that such policies were not advantageous from 1960 to 2007. However, QE can offset a significant portion of the adverse effects of the ELB when the equilibrium real interest rate is low. These improvements in economic performance exceed those associated with moderate increases in the inflation target. Active QE is primarily required when nominal interest rates are near the ELB, pointing to benefits within the model from QE as a secondary tool while relying on short‐term interest rates as the primary tool.

The Effects of Asset Purchases and Normalization of U.S. Monetary Policy

“…Given that the present economic structure remains essentially unchanged, this suggests that the balance sheet policy is likely to remain in the policy toolkit for the Fed to use in response to future economic downturns, as Yellen () anticipates. Our results also support Kiley's () argument that QE can play a useful role in offsetting the adverse effects of the effective lower bound when the equilibrium real interest rate is low. In sum, the findings of this paper generally support the case for an active balance sheet policy, at least as a secondary tool in ordinary times…”

“…Meanwhile, policymakers tend to offer a more positive assessment of the efficacy of LSAPs as a policy tool to respond to future economic downturns (e.g., Bernanke ; Yellen ). In addition, based on simulations, Kiley () suggests that active QE improves economic performance given that equilibrium real interest rates become lower and that interest rates are near their effective lower bound. Now that the postcrisis headwinds have dissipated and normalization of monetary policy is well underway, it is an opportune time to reinvestigate the macroeconomic effects of LSAPs and possible shifts in their effects in the United States.…”

Macroeconomic effects of unconventional balance sheet policies in the United States and The Euro area

“…However, pre-crisis data are not a reliable source of information on the efficiency of unconventional stimulus, as exploiting the asset side of the balance sheet was not used before the 2007 crisis on an unconventional scale. Similarly, closing the system in a DSGE model with a Taylor-type rule may be not adequate during financial distress and ZLB (Michael T. Kiley, 2018;Jesper Lindé, Frank Smets and Rafael Wouters, 2016). Low interest rates that are near the floor in major economies since the outbreak of the Great Recession have increased the risk of a liquidity trap (Lino Sau, 2018).…”

Monetary Policy Options at the Effective Lower Bound: Assessing the Federal Reserve's Current Policy Toolkit

“…Our analysis contributes to a voluminous literature on the conduct of monetary policy at the ELB, including the recent papers by Reifschneider (2016), Kiley and Roberts (2017), and Kiley (2018), which feature methods and models very similar to ours. Relative to those papers, we employ an improved stochastic simulation strategy designed to produce a more realistic distribution of adverse outcomes and an asymmetric monetary policy response function, which captures the sharp declines in the federal funds rate seen during recessions in the data followed by gradual tightening.…”

“…Draws that entail a binding ELB require finding the expected durations of those episodes, a step that adds computation time. Using an alternative approach, which allows for the performance of stochastic simulations over long horizons, Kiley (2018) provides an encouraging assessment of the ratcheting-up risk. Under a proactive LSAP policy, he finds that policymakers would conduct asset purchases roughly 7 percent distribution of the balance sheet size over long horizons are highly uncertain and are likely sensitive to assumptions about the conduct of monetary policy going forward-including the assumption about the longer-run level of reserve balances, the frequency and depth of recessions, the equilibrium level of policy rates, and various other modeling factors that affect ELB risk.…”