Unconventional Policy Tools Research Articles

The Unforeseen Results of Unconventional Monetary Dominance

This empirical study investigates the implications of the substantial size of central banks’ balance sheets and the potential risks of their gradual normalization. Following the global financial crisis of 2008, central banks worldwide implemented unprecedented monetary stimulus measures, including large-scale asset purchases and unconventional policy tools like quantitative easing (QE). As a result, central bank balance sheets expanded significantly, reaching historically unprecedented levels in size and composition. While these measures played a crucial role in stabilizing financial markets and supporting economic recovery, concerns have arisen regarding the eventual reduction of these balance sheets and the possibility of disruptive market dynamics. This research examines the challenges and risks of normalizing central bank balance sheets. Furthermore, it explores the potential occurrence of “hard landing” scenarios, where sudden reductions in balance sheets could trigger financial market turmoil and economic downturns. By analyzing historical precedents and theoretical frameworks, this paper offers valuable insights into the intricate relationship between central bank balance sheets and the dynamics of financial markets. It provides policymakers and market participants with valuable perspectives on navigating the path toward monetary policy normalization.

The growing impact of US monetary policy on emerging financial markets: Evidence from India

Much research has been devoted to studying the international spillover effects of US monetary policy. However, a lot of the focus has been on the recent unconventional monetary policies undertaken by the Federal Reserve. Combining high frequency financial market data with a time-varying parameter approach we show that US monetary policy decisions have had significant effects on the Indian stock markets well before the use of unconventional policy tools and that these effects have gotten stronger over time. In addition to the conventional channel of surprise changes in the policy rate, we find that US monetary shocks are also transmitted through an uncertainty channel, which is especially important for announcements about large scale asset purchases (quantitative easing). Using firm level stock prices, we also show that the higher sensitivity of the aggregate response is uniform across the stock market and is not driven by the increased exposure of any specific industry to US monetary policy. Instead, our results suggest that it is driven by the portfolio decisions of foreign institutional investors, the exchange rate becoming more sensitive to US monetary policy and the global financial cycle working through volatility and risk aversion.

Monetary Transmission Mechanism, Confidence and Uncertainty: Evidence from a Large Emerging Market Economy

After the Global Financial Crisis, the role of uncertainty in driving optimal responses of consumers, firms and policymakers has garnered a renewed focus. In the face of uncertainty, economic agents awaiting information and clarity on future outcomes, may delay their economic decisions. Monetary policy aimed at business cycle stabilization may be rendered ineffective in such situations. We test this hypothesis for a large emerging market economy by analyzing the confidence channel of monetary transmission in India. Using a flexible, local projections-based framework, we find that uncertainty shocks resemble a negative supply shock, contrary to evidence from the developed world. This dominant supply-side effect of uncertainty is crucial in understanding the ineffectiveness of monetary policy transmission once macroeconomic uncertainty is accounted for. An unanticipated increase in uncertainty hinders private investment thereby eroding the productive capacity of the economy. This worsens the inflation-output tradeoff for monetary policy. The weaker monetary policy transmission is corroborated by a non-linear threshold model. Episodes of increased uncertainty may, therefore, require unconventional policy tools for effective management. Our findings are useful for monetary policy in an emerging economy given its objective to maintain price stability and optimize on economic growth.

The stabilization role of police spending in a neo‐Keynesian economy with credit market imperfections

AbstractMotivated by a seemingly persistent “twin‐high” phenomenon in Latin America, we present a novel theoretical framework that has linkages between three institutions (education, criminal justice, and credit) to study policy‐pertinent research questions with regards to whether police spending has the potential to serve as an unconventional policy tool for macroeconomic management. Based on a stylized parameterization, we find formal and illegal human capital to share common cyclical properties, which can be "decoupled" under a rule‐based regime to police spending. This nonetheless comes at a cost of a greater propagation of the credit friction‐induced financial accelerator effect.

Unconventional Monetary Policy Surprises: Delphic or Odyssean?

Central bank communication could be interpreted in two ways, either as central bank's commitment to a future action, known as Odyssean guidance, or its forecast of future economic conditions, known as Delphic guidance. The empirical literature has identified the Delphic and Odyssean components of forward guidance policies. I show that another unconventional policy tool, large-scale asset purchases, can also be empirically decomposed into Delphic and Odyssean components, and these two components have opposing impacts on macroeconomic expectations in the US along with other advanced and emerging market economies. Finally, I estimate the asset price responses to Delphic and Odyssean policies.

Confidence in future monetary policy as a way to overcome the liquidity trap

The global financial crisis of 2007–2009 has changed the landscape for monetary policy. Many central banks in developed economies had to employ various unconventional policy tools to overcome a liquidity trap. These included large-scale asset purchase programs, forward guidance and negative interest rate policies. While recently, some central banks were able to return to conventional monetary policy, for many countries the effectiveness of unconventional policies remains an issue. In this paper we assess diverse practices of unconventional monetary policy with a particular focus on expectations and time consistency. The principal aspect of successful policy in terms of overcoming a liquidity trap is the confidence that interest rates will remain low for a prolonged period. However, forming such expectations faces the problem of time inconsistency of optimal policy. We discuss some directions to solve this problem.

The Effectiveness of Unconventional Monetary Policy in Japan

:Since the global financial crisis of 2007–2008, central bankers around the world have been forced to abandon conventional monetary policy tools in favor of unconventional policies such as quantitative easing, forward guidance, and even lowering the interest rate paid on bank reserves into negative territory. Japan, which faced a crisis in its banking sector and came up against the theoretical zero lower bound on interest rates nearly a decade earlier, was a pioneer in the use of many of these unconventional policy tools. This article analyzes the effectiveness of Japan’s bold experiment with unconventional monetary policy. Using a panel of bi-annual bank data covering the full universe of Japanese commercial banks over a fifteen-year period, this study analyzes the effectiveness of quantitative easing policy on the bank lending channel of monetary policy transmission. Our findings suggest that Japan’s unconventional monetary policy worked: there is a bank lending channel of monetary policy transmission in Japan. These results are robust to the inclusion of time fixed effects and generalized method of moments analysis.

The Growing Impact of US Monetary Policy on Emerging Financial Markets: Evidence from India

Much research has been devoted to studying the international spillover effects of US monetary policy. However, a lot of the focus has been on the recent unconventional monetary policies undertaken by the Federal Reserve. Combining high frequency financial market data with a time-varying parameter approach we show that US monetary policy decisions have had significant effects on the Indian stock markets well before the use of unconventional policy tools and that these effects have gotten stronger over time. In addition to the conventional channel of surprise changes in the policy rate, we find that US monetary shocks are also transmitted through an uncertainty channel, which is especially important for announcements about large scale asset purchases (quantitative easing). Using firm level stock prices, we also show that the higher sensitivity of the aggregate response is uniform across the stock market and is not driven by the increased exposure of any specific industry to US monetary policy. Instead, our results suggest that it is driven by the portfolio decisions of foreign institutional investors and the exchange rate becoming more sensitive to US monetary policy.

Unconventional Policy Tools and its Challenges

The Great Financial Crisis of 2008 not only marks the period of great period accommodation among central bank to support liquidity in the financial system; but also marks the period where Fed, BOJ, ECB and BOE perform a courageous act of policy experimentation. The paper surveyed the different literature on the motivation of cental bank for the used of unconventional policy. Literature survey shows that unconventional tools improved credit condition in the economy and financial inter-mediation of banks. During the Fed’s QE it buys US Treasury bonds which consider as a global safe asset. Large-scale asset purchase of the Fed decreases the supply of safe assets that will create financial instability if not communicated and implemented properly. We see that meaningful recovery is not possible if the financial market is under stress and credit is not intermediated to firms and household. One notable result is that QE works best not on credit channel but mainly on asset price specifically on term premium. Other thing is that the use of unconventoinal tool is proven to face great legal and communication challenges.

The effects of the Fed’s monetary tightening campaign on nonbank mortgage lending

We examine the response of mortgage credit volumes to the Fed’s planned monetary tightening campaign of continued policy rate increases and slowed future purchases of agency securitized mortgages. A shadow policy rate measures unconventional policy tools used at the zero lower bound. After the Great Recession, our results from a time-varying parameter factor-augmented VAR model show that a policy rate increase identified with sign restrictions shifts mortgage lending from banks to less regulated nonbanks. More mortgage funding comes from increased issuance of agency rather than private-label securitized mortgages.

Comments at the Panel “Responders of First or Last Resort: Central Bank Strategies in an Era of Ultra-Low Interest Rates”

There is an emerging consensus among economists that the trend rate of economic growth in the U.S. is much lower now than in the past. In a lower-trend-growth regime, short-term equilibrium real interest rates are lower, all else being equal. In these circumstances monetary policymakers have less room to cut policy rates before hitting the zero lower bound and relying on unconventional policy tools to provide additional accommodation. Moreover, preserving the Fed’s credibility for providing sufficient accommodation to achieve our symmetric inflation objective and maximum employment remains an important consideration. Therefore, risk-management policies favor skewing policy today to lower the chances of facing more difficult zero-lower-bound outcomes in the future.

Defaults, Mandates, and Taxes: Policy Design with Active and Passive Decision-Makers

Growing evidence suggests that many people are surprisingly responsive to unconventional policy tools, such as defaults or choice-framing, yet unresponsive to conventional ones, such as taxes or subsidies. This article studies the optimal choice of policy instrument in settings characterized by such features. We utilize a simple binary-choice model in which decision-makers are either active or passive; active choosers make their decisions by comparing perceived costs and benefits whereas passive choosers select whichever option is the default. From this simple model, a number of results emerge. First, manipulating the default option is preferable to imposing a mandate when active choosers tend to make correct decisions. Second, taxes and defaults are complements, not substitutes; employing the two types of instruments in conjunction can yield better results than utilizing either one alone. Finally, the optimal combination of taxes and defaults is typically preferable to a mandate even in settings where active choosers are prone to biases. The results establish important limits on the range of settings in which mandates are an efficient policy response to decision-maker errors.

Nudges, Mandates, and Taxes: Policy Design with Active and Passive Decision-Makers

Growing evidence suggests that many people are surprisingly responsive to unconventional policy tools, such as defaults or choice-framing, yet unresponsive to conventional ones, such as taxes or subsidies. This paper studies the optimal choice of policy instrument in settings characterized by such features. We utilize a simple binary-choice model in which decision-makers are either active or passive; active choosers make their decisions by comparing perceived costs and benefits whereas passive choosers select whichever option is the default. From this simple model, a number of results emerge. First, manipulating the default option (“nudging”) is preferable to imposing a mandate when active choosers tend to make correct decisions. Second, taxes and nudges are complements, not substitutes; employing the two types of instruments in conjunction can yield better results than utilizing either one alone. Finally, the optimal combination of taxes and nudges is typically preferable to a mandate even in settings where active choosers are prone to biases. The results establish important limits on the range of settings in which mandates are an efficient policy response to decision-maker errors.

The Macroeconomic Effects of the Federal Reserve's Unconventional Monetary Policies

After reaching the effective lower bound for the federal funds rate in late 2008, the Federal Reserve turned to two unconventional policy tools -- quantitative easing and increasingly explicit and forward-leaning guidance for the future path of the federal funds rate -- in order to provide additional monetary policy accommodation. We use survey data from the Blue Chip Economic Indicators to infer changes in private-sector perceptions of the implicit interest rate rule that the Federal Reserve would use following liftoff from the effective lower bound. Using our estimates of the changes over time in private expectations for the implicit policy rule, and estimates of the effects of the Federal Reserve's quantitative easing programs on term premiums derived from other studies, we simulate the FRB/US model to assess the actual economic stimulus provided by unconventional policy since early 2009. Our analysis suggests that the net stimulus to real activity and inflation was limited by the gradual nature of the changes in policy expectations and term premium effects, as well as by a persistent belief on the part of the public that the pace of recovery would be much faster than proved to be the case. Our analysis implies that the peak unemployment effect -- subtracting 1¼ percentage points from the unemployment rate relative to what would have occurred in the absence of the unconventional policy actions -- does not occur until early 2015, while the peak inflation effect -- adding ½ percentage point to the inflation rate -- is not anticipated until early 2016.

The Macroeconomic Effects of the Federal Reserve’s Unconventional Monetary Policies

After reaching the effective lower bound for the federal funds rate in late 2008, the Federal Reserve turned to two unconventional policy tools—quantitative easing and increasingly explicit and forward leaning guidance for the future path of the federal funds rate—in order to provide additional monetary policy accommodation. We use survey data from the Blue Chip Economic Indicators to infer changes in private‐sector perceptions of the implicit interest rate rule that the Federal Reserve would use following liftoff from the effective lower bound. Using our estimates of the changes over time in private expectations for the implicit policy rule, and estimates of the effects of the Federal Reserve’s quantitative easing programs on term premiums derived from other studies, we simulate the FRB/US model to assess the actual economic stimulus provided by unconventional policy since early 2009. Our analysis suggests that the net stimulus to real activity and inflation was limited by the gradual nature of the changes in policy expectations and term premium effects, as well as by a persistent belief on the part of the public that the pace of recovery would be much faster than proved to be the case. Our analysis implies that the peak unemployment effect—subtracting 1¼ percentage points from the unemployment rate relative to what would have occurred in the absence of the unconventional policy actions—does not occur until early 2015, while the peak inflation effect—adding ½ percentage point to the inflation rate—is not anticipated until early 2016.

The Macroeconomic Effects of the Federal Reserve's Unconventional Monetary Policies

After reaching the effective lower bound for the federal funds rate in late 2008, the Federal Reserve turned to two unconventional policy tools--quantitative easing and increasingly explicit and forward-leaning guidance for the future path of the federal funds rate--in order to provide additional monetary policy accommodation. We use survey data from the Blue Chip Economic Indicators to infer changes in private-sector perceptions of the implicit interest rate rule that the Federal Reserve would use following liftoff from the effective lower bound. Using our estimates of the changes over time in private expectations for the implicit policy rule, and estimates of the effects of the Federal Reserve's quantitative easing programs on term premiums derived from other studies, we simulate the FRB/US model to assess the actual economic stimulus provided by unconventional policy since early 2009. Our analysis suggests that the net stimulus to real activity and inflation was limited by the gradual nature of the changes in policy expectations and term premium effects, as well as by a persistent belief on the part of the public that the pace of recovery would be much faster than proved to be the case. Our analysis implies that the peak unemployment effect--subtracting 1-1/4 percentage points from the unemployment rate relative to what would have occurred in the absence of the unconventional policy actions--does not occur until early 2015, while the peak inflation effect--adding 1/2 percentage point to the inflation rate--is not anticipated until early 2016.

Reserve Option Mechanism as a Stabilizing Policy Tool: Evidence from Exchange Rate Expectations

During the recent era, many emerging market economies have implemented unconventional policy measures to mitigate the effect of large swings in short-term capital flows on domestic business cycles. This paper focuses on a specific unconventional policy tool introduced by the Central Bank of Turkey, the Reserve Option Mechanism (ROM), that in principle contains excessive fluctuations in foreign exchange rate and helps cushion the economy from large swings in external factors. Controlling for a set of domestic and external common factors, the results show that USD/TL expectations have exhibited lower levels of volatility, skewness and kurtosis due to implementation of the ROM. Moreover, the higher the intensity of ROM (the fraction of ROM-based reserves in total international reserves) the stronger the effect of ROM on exchange rate expectations. Last, we provide evidence that the mechanism acts as an automatic stabilizer of expectations about excessive movements in the exchange rate: the mechanism decreases the sensitivity of expected USD/TL kurtosis to the common external factor (by an estimated decrease of about 85%).

Strategic Engineered Migration as a Weapon of War

In recent years, it has been widely argued that a new and different armament – i.e., the refugee as weapon – has entered the world's arsenals. But just how new and different is this weapon? Can it only be used in wartime? And just how successful has been its exploitation? Using a combination of statistical data and case study analysis, this article tackles these questions and provides a detailed examination of the instrumental manipulation of population movements as political and military weapons of war. In addition to ‘mapping the terrain’ of the issue by providing a comprehensive typology of the most common means by – and desired ends for – which displaced persons have been used as political and military weapons since the end of the Cold War, the author also provides a portrait of the identities of the kinds of actors most likely to engage in this kind of exploitation. She also proposes an explanation for what motivates them to resort – and apparently increasingly so – to the use of this unconventional policy tool, despite the reputational and potential retributive costs of doing so.

Debt- and Equity-Financed Investment: Equilibrium Structure and Efficiency Implications

This paper considers the financing of investment in the presence of information asymmetry between insiders and outsiders of the firms. It establishes a well-defined capital structure for the economy as a whole with the following features: low-productivity firms rely on the equity market to finance investment at a relatively low level; mediumproductivity firms may not invest at all; and high-productivity firms rely on the debt market to finance investment at a relatively high level. It is shown that the debt market is efficient, with respect to the scope and the amount of investment made by each firm. However, the equity market fails: its scope is too narrow and the amount of investment each firm makes is too little. A unique but rather unconventional policy tool is proposed to achieve constrained Pareto-efficiency, i.e., subsidies to those firms that choose to equity-finance their investment (i.e., equity-market

Capital Flows with Debt- and Equity-Financed Investment: Equilibrium Structure and Efficiency Implications

This paper distinguishes between debt and equity flows in the presence of information asymmetry between the firm`s insiders and outsiders in a small open economy. It shows the inadequacy of capital investment because its scope is too narrow and the investment each firm makes is too little. An unconventional policy tool is proposed to correct the market failure: lump-sum subsidies to firms that choose to equity-finance their investments.