Outside the Box: Unconventional Monetary Policy in the Great Recession and Beyond

TLDR

In November 2008, the Federal Reserve confronted a deepening financial crisis while the federal funds rate was already near zero. The study examines whether the Fed’s unconventional policies during the Great Recession achieved their intended expansionary effects and should be employed again. The Fed implemented quantitative easing by purchasing mortgage‑backed securities and government‑sponsored enterprise debt, expanding its balance sheet five‑fold to $4.5 trillion and holding over 20 % of mortgage‑backed securities and Treasury debt, while also issuing forward guidance on the federal funds rate and later allowing the balance sheet to shrink. Between December 2015 and June 2018, the Fed raised the federal funds rate seven times.

Abstract

In November 2008, the Federal Reserve faced a deteriorating economy and a financial crisis. The federal funds rate had already been reduced to virtually zero. Thus, the Federal Reserve turned to unconventional monetary policies. Through “quantitative easing,” the Fed announced plans to buy mortgage-backed securities and debt issued by government-sponsored enterprises. Subsequent purchases would eventually lead to a five-fold expansion in the Fed’s balance sheet, from $900 billion to $4.5 trillion, and leave the Fed holding over 20 percent of all mortgage-backed securities and marketable Treasury debt. In addition, Fed policy statements in December 2008 began to include explicit references to the likely path of the federal funds interest rate, a policy that came to be known as “forward guidance.” The Fed ceased its direct asset purchases in late 2014. Starting in October 2017, it has allowed the balance sheet to shrink gradually as existing assets mature. From December 2015 through June 2018, the Fed has raised the federal funds interest rate seven times. Thus, the time is ripe to step back and ask whether the Fed’s unconventional policies had the intended expansionary effects—and by extension, whether the Fed should use them in the future.