Evaluating Central Banks' Tool Kit: Past, Present, and Future
We develop a structural DSGE model to systematically study the principal tools of unconventional monetary policy – quantitative easing (QE), forward guidance, and negative interest rate policy (NIRP) – as well as the interactions between them. To generate the same output response, the requisite NIRP and forward guidance interventions are twice as large as a conventional policy shock, which seems implausible in practice. In contrast, QE via an endogenous feedback rule can alleviate the constraints on conventional policy posed by the zero lower bound. Quantitatively, QE1-QE3 can account for two thirds of the observed decline in the “shadow” Federal Funds rate. In spite of its usefulness, QE does not come without cost. A large balance sheet has consequences for different normalization plans, the efficacy of NIRP, and the effective lower bound on the policy rate.
We are grateful to Rich Clarida, Todd Clark, Drew Creal, Andrew Foerster, Yuriy Gorodnichenko, Rob Lester, Leonardo Melosi, Ken Rogoff, and Annette Vissing-Jorgensen, as well as seminar participants at the Conference on Monetary Policy Strategy, Tools, and Communication Practices (A Fed Listens Event), the Federal Reserve Banks of Dallas and Cleveland, the University of Notre Dame, and the University of Wisconsin-Madison, for helpful comments. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.