The Portfolio Balance Channel of Monetary Policy: Evidence from the U.S. Financial Accounts

Abstract

How does monetary policy affect the balance sheet of households? This is an important question in light of the recent large scale asset purchases that have been justified on the grounds of the portfolio balance channel. Many studies have attempted to quantify the effect of these LSAPs and find evidence for the portfolio channel. Most of these studies, however, focus only on one manifestation of the portfolio channel, the change in relative yields and typically do so in the narrow context of the zero lower bound. Little is empirically known about this channel in more conventional settings. This paper attempts to fill this gap in the literature by examining the overall validity of the channel away from the zero lower bound. We do this by examining how household portfolios responded to monetary policy shocks to the monetary base and to inflation forecasts for the period 1959:Q1 – 2007:Q4. We find strong evidence that the portfolio channel is an important part of the monetary transmission mechanism.