Unconventional Monetary Policy during the Great Recession: Theory, Empirical Evidence and Limitations Kilian Rieder 1 1 University of Oxford, kilian.rieder@univ.ox.ac.uk Paris Dauphine, London Campus Guest Lecture 10 April 2018 Rieder (Oxford) Unconventional Monetary Policy 10 April 2018 1 / 37
Outline 1 Group exercise & plenary discussion: terms and definitions (30min) 2 Motivating unconventional monetary policy (25min) 3 Break (5min) 4 Defining unconventional monetary policy & its channels (30min) 5 Empirical evidence: US, UK, Eurozone (20min) 6 Limitations, risks & consequences (10min) Rieder (Oxford) Unconventional Monetary Policy 10 April 2018 2 / 37
Readings Carlin & Soskice (2015). Macroeconomics - Institutions, Instability and the Financial System. OUP. Chapters 3, 5, 7, 13. Special issue of Oxford Review of Economic Policy published in Winter 2012: Bowdler and Radia: the definition and transmission channels of QE Breedon, Chadha and Waters: the theory and empirics of QE Martin and Milas: international evidence on QE Goodhart and Ashworth: limitations of QE Joyce, Tong and Woods (2011). The United Kingdom’s quantitative easing policy: design, operation and impact. Bank of England Quarterly Bulletin, no. 3. Gorton and Metrick (2012). Getting up to speed on the financial crisis: a one-weekend reader’s guide. Journal of Economic Literature 50(1), p. 128-50. Goodhart (1999). Myths about the Lender of Last Resort. International Finance 2(3), pp.339-360. Freixas, Parigi and Rochet (2004). The Lender of Last Resort: A 21st century approach. Journal of the European Economic Association 2(6): pp. 1085–1115. Rieder (Oxford) Unconventional Monetary Policy 10 April 2018 3 / 37
Part I: Group exercise & discussion Rieder (Oxford) Unconventional Monetary Policy 10 April 2018 4 / 37
Part II: Motivation – Why and when do we need UMP? Rieder (Oxford) Unconventional Monetary Policy 10 April 2018 5 / 37
Central bank responses to the Great Recession Rieder (Oxford) Unconventional Monetary Policy 10 April 2018 6 / 37
Central bank responses to the Great Recession What happened? Rieder (Oxford) Unconventional Monetary Policy 10 April 2018 6 / 37
Central bank responses to the Great Recession What happened? Global financial crisis starting in US: Bear Stearns, Lehman etc. Large demand shock: negative output gap, disinflationary pressures Rieder (Oxford) Unconventional Monetary Policy 10 April 2018 6 / 37
Central bank responses to the Great Recession What happened? Global financial crisis starting in US: Bear Stearns, Lehman etc. Large demand shock: negative output gap, disinflationary pressures What did central banks do? Rieder (Oxford) Unconventional Monetary Policy 10 April 2018 6 / 37
Central bank responses to the Great Recession What happened? Global financial crisis starting in US: Bear Stearns, Lehman etc. Large demand shock: negative output gap, disinflationary pressures What did central banks do? Conventional monetary policy: large interest rate cuts Usual interest decisions: ∆ 25 bp Federal Reserve: 50 bp in September 2007, followed by 50-75 bp every other month until December 2008 Bank of England: starting in gradually in December 2007, big hike of 150 bp in November 2008 ECB: latecomer with first cut in fall 2008 Consequence: interest rates approach level of zero by 2009 Rieder (Oxford) Unconventional Monetary Policy 10 April 2018 6 / 37
Central bank responses to the Great Recession What happened? Global financial crisis starting in US: Bear Stearns, Lehman etc. Large demand shock: negative output gap, disinflationary pressures What did central banks do? Conventional monetary policy: large interest rate cuts Usual interest decisions: ∆ 25 bp Federal Reserve: 50 bp in September 2007, followed by 50-75 bp every other month until December 2008 Bank of England: starting in gradually in December 2007, big hike of 150 bp in November 2008 ECB: latecomer with first cut in fall 2008 Consequence: interest rates approach level of zero by 2009 Why did central bank intervene so heavily? Rieder (Oxford) Unconventional Monetary Policy 10 April 2018 6 / 37
Central bank responses to the Great Recession What happened? Global financial crisis starting in US: Bear Stearns, Lehman etc. Large demand shock: negative output gap, disinflationary pressures What did central banks do? Conventional monetary policy: large interest rate cuts Usual interest decisions: ∆ 25 bp Federal Reserve: 50 bp in September 2007, followed by 50-75 bp every other month until December 2008 Bank of England: starting in gradually in December 2007, big hike of 150 bp in November 2008 ECB: latecomer with first cut in fall 2008 Consequence: interest rates approach level of zero by 2009 Why did central bank intervene so heavily? Avoid experience of Great Depression Some important lessons from history Policy-makers aware of GD experience Rieder (Oxford) Unconventional Monetary Policy 10 April 2018 6 / 37
Rieder (Oxford) Unconventional Monetary Policy 10 April 2018 7 / 37
Rieder (Oxford) Unconventional Monetary Policy 10 April 2018 8 / 37
Rieder (Oxford) Unconventional Monetary Policy 10 April 2018 9 / 37
Running out of ammunition Rieder (Oxford) Unconventional Monetary Policy 10 April 2018 10 / 37
Running out of ammunition Situation in 2009/2010: Rieder (Oxford) Unconventional Monetary Policy 10 April 2018 10 / 37
Running out of ammunition Situation in 2009/2010: Reaching the zero lower bound of interest rates Still severe contraction, inflation falling European debt crisis reinforces problem in Eurozone Rieder (Oxford) Unconventional Monetary Policy 10 April 2018 10 / 37
Running out of ammunition Situation in 2009/2010: Reaching the zero lower bound of interest rates Still severe contraction, inflation falling European debt crisis reinforces problem in Eurozone Why can central banks not cut rates below zero? Rieder (Oxford) Unconventional Monetary Policy 10 April 2018 10 / 37
Running out of ammunition Situation in 2009/2010: Reaching the zero lower bound of interest rates Still severe contraction, inflation falling European debt crisis reinforces problem in Eurozone Why can central banks not cut rates below zero? They could, at least in theory Example: Riksbank (Sweden), Swiss National Bank However, negative rates unlikely to be effective everywhere or over LT Negative interest rate: tax on depositors and investors How to avoid it? Hoard cash, e.g. at home in you cellar Why? Your cellar provides an interest rate of zero Limit to hoarding = success of negative rates if storage is costly/dangerous (e.g. insurance) Rieder (Oxford) Unconventional Monetary Policy 10 April 2018 10 / 37
Running out of ammunition Situation in 2009/2010: Reaching the zero lower bound of interest rates Still severe contraction, inflation falling European debt crisis reinforces problem in Eurozone Why can central banks not cut rates below zero? They could, at least in theory Example: Riksbank (Sweden), Swiss National Bank However, negative rates unlikely to be effective everywhere or over LT Negative interest rate: tax on depositors and investors How to avoid it? Hoard cash, e.g. at home in you cellar Why? Your cellar provides an interest rate of zero Limit to hoarding = success of negative rates if storage is costly/dangerous (e.g. insurance) Why not just wait and see? Rieder (Oxford) Unconventional Monetary Policy 10 April 2018 10 / 37
Running out of ammunition Situation in 2009/2010: Reaching the zero lower bound of interest rates Still severe contraction, inflation falling European debt crisis reinforces problem in Eurozone Why can central banks not cut rates below zero? They could, at least in theory Example: Riksbank (Sweden), Swiss National Bank However, negative rates unlikely to be effective everywhere or over LT Negative interest rate: tax on depositors and investors How to avoid it? Hoard cash, e.g. at home in you cellar Why? Your cellar provides an interest rate of zero Limit to hoarding = success of negative rates if storage is costly/dangerous (e.g. insurance) Why not just wait and see? Large welfare costs: unemployment Deflationary trap Rieder (Oxford) Unconventional Monetary Policy 10 April 2018 10 / 37
Deflationary trap (I): background Rieder (Oxford) Unconventional Monetary Policy 10 April 2018 11 / 37
Deflationary trap (I): background What does monetary policy normally try to achieve? Rieder (Oxford) Unconventional Monetary Policy 10 April 2018 11 / 37
Deflationary trap (I): background What does monetary policy normally try to achieve? Today, central banks try to achieve inflation target Target ( π T ) = rate of inflation consistent with equilibrium output and equilibrium unemployment Equilibrium output = no output gap Equilibrium unemployment = unemployment equal to NAIRU Rieder (Oxford) Unconventional Monetary Policy 10 April 2018 11 / 37
Deflationary trap (I): background What does monetary policy normally try to achieve? Today, central banks try to achieve inflation target Target ( π T ) = rate of inflation consistent with equilibrium output and equilibrium unemployment Equilibrium output = no output gap Equilibrium unemployment = unemployment equal to NAIRU How does conventional monetary policy achieve this? Rieder (Oxford) Unconventional Monetary Policy 10 April 2018 11 / 37
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