Abstract
In this paper, we compare the transmission of a conventional monetary policy shock with that of an unexpected decrease in the term spread, which mirrors quantitative easing. Employing a time-varying vector autoregression with stochastic volatility, our results are two-fold: First, the spread shock works mainly through a boost to consumer wealth growth, while a conventional monetary policy shock affects real output growth via a broad credit/bank lending channel. Second, both shocks exhibit a distinct pattern over our sample period. More specifically, we find small output effects of a conventional monetary policy shock during the period of the global financial crisis and stronger effects in its aftermath. This might imply that when the central bank has left the policy rate unaltered for an extended period of time, a policy surprise might boost output particularly strongly. By contrast, the spread shock has affected output growth most strongly during the period of the global financial crisis and less so thereafter. This might point to diminishing effects of large-scale asset purchase programs.
Highlights
With the onset of the global financial crisis, the U.S Federal Reserve (Fed) began to lower interest rates to stimulate the economy
We investigate the transmission of the monetary policy and the term spread shock, examine whether overall effects vary over time and establish that both shocks mattered historically in determining fluctuations in the time series considered in this paper
We show the evolution of the actual federal funds rate and the term spread in the right panel
Summary
With the onset of the global financial crisis, the U.S Federal Reserve (Fed) began to lower interest rates to stimulate the economy. Engen et al (2015) emphasized the role of quantitative easing in underpinning the commitment of the Fed to be accommodative for a longer period This signaling channel is more effective when financial markets are impaired and economic conditions characterized by high uncertainty. Conventional monetary policy works strongly through expanding assets and deposits of the banking sector, while the impact on consumer wealth growth is more modest Last, for both shocks, we find a distinct pattern over our sample period. The spread shock has affected output growth most strongly during the period of the global financial crisis, when the Fed launched its first asset purchase program, and less so thereafter.
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