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Interpreting the Unconventional U.S. Monetary Policy of 2007-09

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  • Reis, Ricardo

Abstract

This paper reviews the unconventional U.S. monetary policy responses to the financial and real crises of 2007-09, divided into three groups: interest rate policy, quantitative policy, and credit policy. To interpret interest rate policy, it compares the Federal Reserve’s actions with the literature on optimal policy in a liquidity trap. This comparison suggests that policy has been in the direction indicated by theory, but it has not gone far enough. To interpret quantitative policy, the paper reviews the determination of inflation under different policy regimes. The main danger for inflation from current actions is that the Federal Reserve may lose its policy independence; a beneficial side effect of the crisis is that the Friedman rule can be implemented by paying interest on reserves. To interpret credit policy, the paper presents a new model of capital market imperfections with different financial institutions and a role for securitization , leveraging, and mark-to-market accounting. The model suggests that providing credit to traders in securities markets is a more effective response than extending credit to the originators of loans.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7635.

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Date of creation: Jan 2010
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Handle: RePEc:cpr:ceprdp:7635

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Keywords: financial crisis; liquidity; liquidity trap; price-level determination;

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References

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  1. Kiminori Matsuyama, 2007. "Aggregate Implications of Credit Market Imperfections," NBER Working Papers 13209, National Bureau of Economic Research, Inc.
  2. Alan Auerbach & Maurice Obstfeld, 2004. "The Case for Open-Market Purchases in a Liquidity Trap," Macroeconomics, EconWPA 0407009, EconWPA.
  3. Sims, Christopher A, 1994. "A Simple Model for Study of the Determination of the Price Level and the Interaction of Monetary and Fiscal Policy," Economic Theory, Springer, Springer, vol. 4(3), pages 381-99.
  4. Frederic S. Mishkin, 2007. "Monetary Policy Strategy," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262134829, December.
  5. Berriel Tiago C & Bhattarai Saroj, 2009. "Monetary Policy and Central Bank Balance Sheet Concerns," The B.E. Journal of Macroeconomics, De Gruyter, De Gruyter, vol. 9(1), pages 1-33, January.
  6. Michael Woodford, 1995. "Price Level Determinacy Without Control of a Monetary Aggregate," NBER Working Papers 5204, National Bureau of Economic Research, Inc.
  7. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 85(3), pages 473-91, June.
  8. Matthew B. Canzoneri & Robert E. Cumby & Behzad T. Diba, 2001. "Is the Price Level Determined by the Needs of Fiscal Solvency?," American Economic Review, American Economic Association, vol. 91(5), pages 1221-1238, December.
  9. Gary B. Gorton, 2009. "Information, Liquidity, and the (Ongoing) Panic of 2007," NBER Working Papers 14649, National Bureau of Economic Research, Inc.
  10. Lars E.O. Svensson, 2003. "Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others," NBER Working Papers 10195, National Bureau of Economic Research, Inc.
  11. Markus K. Brunnermeier, 2009. "Deciphering the Liquidity and Credit Crunch 2007-2008," Journal of Economic Perspectives, American Economic Association, vol. 23(1), pages 77-100, Winter.
  12. Romer, Christina D., 1992. "What Ended the Great Depression?," The Journal of Economic History, Cambridge University Press, Cambridge University Press, vol. 52(04), pages 757-784, December.
  13. Gauti B. Eggertsson & Michael Woodford, 2003. "The Zero Bound on Interest Rates and Optimal Monetary Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 34(1), pages 139-235.
  14. Franklin Allen & Ana Babus & Elena Carletti, 2009. "Financial Crises: Theory and Evidence," Annual Review of Financial Economics, Annual Reviews, vol. 1(1), pages 97-116, November.
  15. Reis, Ricardo, 2007. "The analytics of monetary non-neutrality in the Sidrauski model," Economics Letters, Elsevier, vol. 94(1), pages 129-135, January.
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Citations

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Cited by:
  1. Ansgar Belke & Jens Klose, 2010. "(How) Do the ECB and the Fed React to Financial Market Uncertainty?: The Taylor Rule in Times of Crisis," Discussion Papers of DIW Berlin 972, DIW Berlin, German Institute for Economic Research.
  2. Duca, John V., 2013. "Did the commercial paper funding facility prevent a Great Depression style money market meltdown?," Journal of Financial Stability, Elsevier, Elsevier, vol. 9(4), pages 747-758.
  3. Zeng, Zhixiong, 2010. "A theory of the non-neutrality of money with banking frictions and bank recapitalization," MPRA Paper 24752, University Library of Munich, Germany.
  4. Chao Gu & Joseph Haslag, 2014. "Unconventional Optimal Open Market Purchases," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 17(3), pages 543-558, July.
  5. Fabio Bagliano & Claudio Morana, 2010. "The Great Recession: US dynamics and spillovers to the world economy," CeRP Working Papers 103, Center for Research on Pensions and Welfare Policies, Turin (Italy).
  6. Claudio Morana, 2013. "Factor Vector Autoregressive Estimation of Heteroskedastic Persistent and Non Persistent Processes Subject to Structural Breaks: New Insights on the US OIS SPreads Term Structure," Working Papers, University of Milano-Bicocca, Department of Economics 233, University of Milano-Bicocca, Department of Economics, revised Feb 2013.
  7. Duca, John V. & Murphy, Anthony, 2013. "Would a Bagehot style corporate bond backstop have helped counter the Great Recession?," Economics Letters, Elsevier, vol. 119(3), pages 351-353.
  8. Zhixiong Zeng, 2013. "A theory of the non-neutrality of money with banking frictions and bank recapitalization," Economic Theory, Springer, Springer, vol. 52(2), pages 729-754, March.
  9. Nuno Cassola & Claudio Morana, 2010. "The 2007-? financial crisis: a euro area money market perspective," ICER Working Papers - Applied Mathematics Series, ICER - International Centre for Economic Research 35-2010, ICER - International Centre for Economic Research.
  10. Gonzalez-Astudillo, Manuel, 2011. "Policy Rule Coefficients Driven by Latent Factors: Monetary and Fiscal Policy Interactions in an Endowment Economy," MPRA Paper 29976, University Library of Munich, Germany.

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