Central banks have used various unconventional monetary policy tools since the onset of the financial crisis yet the debate continues regarding their efficiency. This column attempts to shed light on the ‘bang for the buck’, or the macroeconomic effects, of one such unconventional monetary policy – the Federal Reserve’s large-scale asset purchases of mortgage-backed securities employed during the Fed’s QE1 and QE3 programs.
It is now well established that central banks can affect the long-term yields of government bonds and other financial assets. Yet, given the volume of assets that have been purchased by central banks in recent years, the literature on its macroeconomic effects is surprisingly thin. Most studies analyse the effect of QE on the macroeconomy exclusively through the term premium. Chen et al. (2012) and Wu and Xia (2014) are two representative examples of this approach. Chen et al. (2012) provide an estimate of the effect of QE2 by using a dynamic stochastic general equilibrium (DSGE) model with segmented bond markets. They find that effects on GDP and inflation are almost negligible. Wu and Xia (2014) instead apply a statistical model to forward rates on Treasuries in order to compute a ‘shadow rate’ that applies when the policy rate is constrained at the zero lower bound. In a second step, they compute the macroeconomic effects from this shadow rate and find that they are small – the Federal Reserve’s unconventional monetary policy during 2009–2013 reduced unemployment by 0.13% by December 2013.
Alternatives to the term premium approach also exist. Gambacorta et al. (2014) use the size of the central bank balance sheet as the instrument affecting the economy in a structural VAR. Alternatively, Weale and Wieladek (2014) include asset purchase announcements in a structural VAR (see also the related Vox column). The latter study finds substantial effects of QE1 on GDP and inflation. For the US (UK), they obtain a GDP increase of 0.7% (2.5%) and a CPI price level increase of 0.8% (4.2%).
Effects on the macroeconomy through the mortgage spread
Another strand of the literature has focused on the macroeconomic effects of the ‘mortgage spread’ – the difference in the interest rate between mortgages and government bonds at a given maturity. Guerrieri and Lorenzoni (2011) and Hall (2011) build theoretical models concerning the effect of the mortgage spread on aggregate quantities.
My recent paper (Walentin 2014) is the first that quantifies the macroeconomic effects of large-scale asset purchases through the reduction in the mortgage spread. The paper uses a structural VAR approach on US mortgage spreads and macroeconomic variables to estimate the effects of mortgage spread shocks on the business cycle. A mortgage shock of 100 basis points yields a decrease of 1.6% in consumption, 6.2% in residential investment, and 1.9% in GDP. These responses are gradual and reach a trough after more than one year. House prices respond faster and decline by 2.6%. Qualitatively similar results are found for the UK and Sweden. However, the mortgage spread shock is more important for aggregate quantities and house prices in these countries compared to the US, and its impact is faster. This difference may be due to the much shorter duration of the typical mortgage contract in the UK and Sweden compared to in the US.
Hancock and Passmore (2011) find that QE1 reduced the mortgage spread in the US by 100–150 basis points, although other studies indicate smaller effects. This implies that the above example of a 100 basis point shock is a decent approximation of how much QE1 affected the US economy through a reduction in the mortgage spread. Note that this calculation abstracts from any effect of QE1 on the macroeconomy through the term spread – the channel emphasised by earlier studies.
In contrast to the earlier literature on macroeconomic effects of asset purchases, my recent paper (Walentin 2014) focuses on mortgage rates and their spread against government bonds. An important conclusion emerging from my research is that unconventional monetary policy in the form of central bank purchases of mortgage-backed securities has substantial macroeconomic effects. However, this does not necessarily imply that large-scale asset purchases are the best policy tool at the zero lower bound. Clearly, many other aspects of these purchases are not yet fully explored – for example, their effects on agency problems or their distributional effects.
Author’s note: The views expressed in this column are solely the responsibility of the author and should not be interpreted as reflecting the views of the Executive Board of Sveriges Riksbank.
Chen, H, V Cúrdia, and A Ferrero (2012), “The Macroeconomic Effects of Large-Scale Asset Purchase Programs”, Economic Journal, 122(564): 289–315.
Gambacorta, L, B Hofmann, and G Peersman (2014), “The Effectiveness of Unconventional Monetary Policy at the Zero Lower Bound: A Cross-Country Analysis”, Journal of Money, Credit and Banking, 46: 615–642.
Guerrieri, V and G Lorenzoni (2011), “Credit Crises, Precautionary Savings and the Liquidity Trap’’, NBER Working Paper 17583.
Hall, R (2011), “The High Sensitivity of Economic Activity to Financial Frictions”, Economic Journal, 121: 351–378.
Hancock, D and W Passmore (2011), “Did the Federal Reserve’s MBS Purchase Program Lower Mortgage Rates?”, Journal of Monetary Economics, 58: 498–514.
Walentin, K (2014), “Business Cycle Implications of Mortgage Spreads”, Journal of Monetary Economics, 67: 62–77.
Weale, M and T Wieladek (2014), “What are the macroeconomic effects of asset purchases?”, Bank of England External MPC Unit Discussion Paper 42.
Wu, C and F Xia (2014), “Measuring the Macroeconomic Impact of Monetary Policy at the Zero Lower Bound”, Chicago Booth Working Paper 13-77 and NBER Working Paper 20117.