Evaluating the Fed’s crisis tools
In this paper, Silvana Tenreyro and Mo Wazzi examine the Federal Reserve’s use of forward guidance (FG) and large-scale asset purchases (LSAPs) during and after the Covid-19 pandemic, focusing on tool design and effectiveness rather than policy stance appropriateness. Their key findings:
Forward guidance
Effectiveness: Forward guidance remains an effective monetary policy tool, with empirical evidence showing it reduces market uncertainty and influences asset prices. Under the Fed’s flexible average inflation targeting (FAIT) framework, clear reaction-function guidance can be sufficiently stimulative without requiring time-inconsistent commitments.
Design issues: The 2020 guidance created potential constraints by requiring simultaneous achievement of employment and inflation goals, relying heavily on realized rather than projected data, and establishing rigid sequencing between asset purchase tapering and rate increases.
Large-scale asset purchases
Transmission channels: LSAPs operate through multiple mechanisms including portfolio balance effects (most empirically supported), liquidity provision (critical during market dysfunction), signaling effects (less evidence for recent programs), and bank lending channels (mixed evidence).
Macroeconomic impact: Substantial uncertainty exists about LSAPs’ real economic effects, with wide dispersion in estimated impacts across studies. While asset price effects are well-established, translating these into macroeconomic outcomes remains contentious.
Key recommendations
- Stress-test policy tools before implementation using scenario analysis to manage trade-offs between commitment and flexibility
- Separate asset purchase objectives – distinguish between purchases for market functioning versus monetary accommodation to enhance policy agility
- Design forward-looking guidance that avoids excessive reliance on realized data and incorporates well-integrated escape clauses
- Emphasize Delphic over Odyssean guidance – under FAIT, reaction-function clarification can be sufficiently stimulative without time-inconsistent commitments
- Avoid rigid tool sequencing that may constrain policy flexibility when economic conditions evolve rapidly
2020-2024 Experience lessons
The Fed’s policies successfully addressed market dysfunction in March 2020, but the guidance structure may have limited adaptability as inflation surged. The failure to clearly distinguish between liquidity support and monetary stimulus objectives reduced policy agility and complicated communication.
Future considerations
The paper emphasizes that while unconventional tools should remain in the Fed’s toolkit, their design requires careful consideration of inherent trade-offs. Cost-benefit assessments must move beyond narrow fiscal metrics to incorporate broader macroeconomic objectives, noting that accounting losses from successful stimulus policies should be viewed as features rather than bugs of effective intervention.
Unconventional Policy Tools at the Fed: Lessons from theory and practice
Authors: Silvana Tenreyro, Mo Wazzi
From: London School of Economics, University of Oxford
Evaluating the ECB’s crisis tools
This paper by Robert Holzmann examines the use of unconventional monetary policy (UMP) measures by central banks following the global financial crisis, their effectiveness, unintended consequences, and implications for future monetary policy. The analysis focuses primarily on the European Central Bank’s experience but draws broader lessons for central banking.
The ECB deployed four main UMP tools when conventional policy reached its limits:
- Negative Interest Rate Policies (NIRP): The ECB’s deposit facility rate remained negative from 2014 to 2022, designed to encourage lending while discouraging excessive saving. However, this policy impaired bank profitability and created risks of resource misallocation.
- Asset Purchase Programmes (Quantitative Easing): Large-scale bond purchases aimed at lowering long-term yields and expanding central bank balance sheets. These programs raised concerns about asset bubbles and market distortions.
- Funding for Lending Programs: TLTROs provided over EUR 2.2 trillion in long-term funding to banks by 2021, creating unintended subsidies to the banking sector.
- Forward Guidance: Communication strategies to anchor inflation expectations, though effectiveness depended heavily on central bank credibility.
Effectiveness and consequences
Most empirical studies found that UMP measures broadly succeeded in supporting economic activity and raising inflation toward targets. The theoretical effects of these policies were generally observed in practice. The perceived success came with substantial negative consequences:
- Financial stability risks: NIRP adversely affected bank net interest margins and encouraged excessive risk-taking
- Resource misallocation: Evidence suggests QE and funding programs contributed to “zombification” of firms and inefficient capital allocation
- Distributional effects: Strong links between expansionary monetary policy and increased house prices, widening wealth gaps between property owners and renters
Central bank financial impact
UMP created significant financial challenges for central banks through massive balance sheet expansion and maturity mismatches. When policy rates rose after 2021, central banks faced prolonged losses due to paying higher rates on short-term deposits while holding low-yielding long-term assets. Projections suggest some Eurosystem central banks may incur losses until around 2030, with full capital restoration taking potentially a decade longer.
Alternative policy approaches
The paper evaluates three alternatives for conventional monetary policy at the ELB:
- Make-up strategies: Average inflation targeting and price level targeting show limited empirical evidence and mixed results
- Asymmetric Reaction Functions: More aggressive responses to undershooting versus overshooting inflation targets, adopted by the ECB in 2021 but with limited public understanding
- Raising Inflation Targets: Higher targets could avoid ELB constraints but risk damaging central bank credibility through cumulative inflation effects
Conclusions
While UMP measures provided necessary economic stimulus during crisis periods, they created substantial long-term costs and risks that may be underestimated. The lack of comprehensive research on unintended consequences, combined with evidence of financial stability risks, resource misallocation, and widening inequalities, challenges the wisdom of heavy reliance on such measures. Central banks need adaptable frameworks with diverse UMP tools while learning from past experiences to improve effectiveness and efficiency.
Unconventional monetary policy under review
Author: Robert Holzmann
From: Oesterreichische Nationalbank
