After policy rates fell close to zero in response to the global financial crisis of 2008-09, the scope for further conventional monetary policy easing was exhausted. As a result, both the Bank of England and the Federal Reserve embarked on large-scale asset purchases of government and financial securities (see Figures 1 and 2).
The aim of these policies was to increase output and prevent deflation, thereby supporting the Bank of England’s 2% inflation target and the Federal Reserve’s ‘dual mandate’. However, the transmission channels and effects of unconventional monetary policy are much less well understood than those of conventional interest rate-based monetary policy.
Studies that examine the impact of unconventional monetary policy on the wider macroeconomy typically adopt Bayesian VAR methods or use structural macroeconomic models. An example of the latter is Chung et al. (2012), which uses a calibrated version of the Federal Reserve Board’s US macroeconomic model and finds that real GDP and inflation were respectively 3% and 1% higher as a result of the Federal Reserve’s asset-purchase policy. Bayesian VAR studies typically identify a ‘spread shock’, which is identified as a shock that reduces the spread between the long and short rate, raises output and prices, but does not affect the short rate. Under the assumption that this shock reflects asset-purchase policy, previous studies (Baumeister and Benati 2013, Kapetanios et al. 2012) quantify the impact of this policy on real GDP and CPI in the UK and the US.
New evidence on the effects of quantitative easing
In recent work (Weale and Wieladek 2014), we re-examine whether these policies had an impact on output and inflation. After all, there are many other factors that could have been responsible for the economic recovery following asset purchase announcements in these countries.
Unfortunately, the impulse response analysis in previous Bayesian VAR work cannot be used to answer that question, as restrictions on output and prices are imposed as part of the identification scheme. In contrast, we adopt three identification schemes that make no prior assumptions about the effect of the policy on output and inflation. A second important distinction from previous work is that we estimate our Bayesian VAR model on monthly data from March 2009, when asset purchases started, to May 2013. Finally, we identify asset-purchase announcement shocks directly, as opposed to attributing movements in spread shocks to unconventional monetary policy.
Our results suggest that an asset-purchase shock that results in an announcement worth 1% of nominal GDP leads to a rise in real GDP of about 0.36% in the US and 0.18% in the UK; and to a rise in the CPI of 0.38% in the US and 0.3% in the UK. These findings are encouraging, because they suggest that asset purchases can be effective in stabilising output and prices. The implied UK Phillips curve is steeper than in the US, meaning that the same change in output would have a relatively greater impact on UK inflation. Quantitatively, monetary easing leading to a 1% rise in output results in a 1% rise in the US CPI, whereas in the UK the CPI rises by 1.5%. These estimates of the inflation–output trade-off are similar to those that previous studies reported for conventional (interest rate-based) monetary policy. Table 1 compares the implied effect on output and prices with that reported in previous studies of unconventional monetary policy. For real GDP, our reported figures are very similar to those reported in previous studies. For the US, we also find a similar effect on the CPI, but for the UK, our results suggest that the impact on the CPI is almost three times as large as the effect reported in Baumeister and Benati (2013) and Kapetanios et al. (2012).
Table 1. Comparison of estimated impact of QE1 across various studies
Transmission channels of asset purchases
Our approach also allows us to examine the different transmission channels of asset purchase policy. For the UK, asset purchase announcements have an impact on interest rate futures in the UK and measures of financial market uncertainty, suggesting that ‘signalling’ is an important transmission channel. For the US, only long-term yields and the real exchange rate react to asset purchase shocks, which implies a relatively greater role for the portfolio rebalancing channel. But asset purchases in both countries affect measures of financial-market uncertainty, such as the VIX. This suggests that asset-purchase announcements may also provide economic stimulus through a reduction in uncertainty, which is a channel that has not received much attention in previous work.
Effects on emerging markets
A common complaint by policymakers in emerging market economies is that asset purchases in the UK and the US led to capital inflows to these countries, thereby contributing to rises in domestic asset prices and future financial instability. We do not find an impact on capital flows to emerging markets, but there is an effect on sovereign and corporate spreads, as well as industrial production in those countries. One potential explanation for this pattern is that UK and US asset-purchase policy stabilised economic conditions in the target export markets of these countries. If this is the correct explanation, then one would not necessarily expect a negative spillover effect on emerging market economies from UK and US asset sales, so long as these are accompanied by economic growth in these countries.
Chung, H, J Laforte, D Reifschneider, and J C Williams (2011), Estimating the Macroeconomic Effects of the Fed’s Asset Purchases”, Federal Reserve Bank of San Fransisco Economic Letter, 2011(3): 1–5.
Baumeister, C and L Benati (2013), “Unconventional Monetary Policy and the Great Recession: Estimating the Macroeconomic Effects of a Spread Compression at the Zero Lower Bound”, International Journal of Central Banking, 9(2): 165–212.
Kapetanios, G, H Mumtaz, I Stevens, and K Theodoridis (2012), “Assessing the economy-wide effects of quantitative easing”, Economic Journal, 122(564): F316–F347.
Weale, M and T Wieladek (2014), “What are the macroeconomic effects of asset purchases?”, External MPC Unit Discussion Paper 42.