What is Unorthodox Monetary Policy?

Abstract

After the near collapse of the global financial system after the default of Lehmann Brothers money markets froze and caused the problem of the massive contagion process of a global liquidity crisis. To counter this process the Fed, the ECB and the Bank of England in particular started monetary activities summarized under the label of unorthodox monetary policies (see Muellbauer 2008). Until that time orthodox monetary policies, i.e. interest rate policies, were the key instrument to guide the liquidity provision of money markets. After already lowering key interest rates of the central banks rapidly close to zero and money market still not recover from the shock, monetary policy was considered to become stuck in the liquidity trap. However, Demand for liquidity still stayed at extraordinary high levels even if the price of money has decreased to near zero. Uncertainty about future developments of the still unfolding crisis triggered a money hoarding unseen before after WWII. The key question therefore was: How to pump prime money markets to make them operate again normally? The remedy put into practice was unorthodox monetary policy. But what does this mean? Has the Fed and the ECB violated the legal framework? What are the short‐term and long‐ term impacts of unorthodox monetary policies of the Fed and the ECB? Do unorthodox monetary policies create long‐term new endogenous risks of further financial market instability? What kind of new moral hazard related to unorthodox monetary policies emerges? Is the Fed and the ECB lacking a credible exit strategy? JEL‐Codes: E52, E58, E42, E43