Into the Universe of Unconventional Monetary Policy: State-dependence, Interaction and Complementarities

This paper studies the interaction among non-standard monetary policy measures – the negative interest rate policy, forward guidance and quantitative easing – and their ability to substitute conventional policy rate setting when it is constrained by the effective lower bound. In this paper, the euro area serves as our laboratory since the European Central Bank has deployed all three unconventional measures in the past decade to bypass the binding effective lower bound constraint and stabilize the inflation trajectory towards the target. Our empirical setup makes use of a smooth-transition structural vector autoregression, while identification of monetary innovations is done via fusion of high frequency information with narrative sign restrictions, first introduced in Zlobins (2021b) and now further extended to isolate rate cuts in positive/negative territory, allowing to simultaneously identify the impact of both conventional and unconventional policy actions. Our findings show that unconventional measures can substitute the standard policy rate setting but their effectiveness is highly dependent on the overall policy mix and the state of the economy. However, the evidence also suggests that non-standard measures serve as complements to the conventional policy as they are particularly powerful in circumstances when standard policy rate setting loses its stabilization properties, for example, during market turbulence or when the risk of de-anchoring of inflation expectations is elevated.