Monetary Policy Alternatives at the Zero Bound: An Empirical Assessment

This 2004 Brookings Papers on Economic Activity paper by Ben Bernanke, Vincent Reinhart, and Brian Sack asks whether “nonstandard” monetary policies can still work once the short-term policy rate is at or near the zero lower bound (ZLB), applying “the methods of modern empirical finance” to the recent US and Japanese experience rather than relying on theory alone. The authors group nonstandard policies into three classes — using communications to shape expected future policy, increasing the size of the central bank’s balance sheet (quantitative easing), and changing its composition (targeted asset purchases) — and use two complementary empirical strategies to assess each. For communications, a one-hour event study around 116 FOMC decisions (July 1991-2004) decomposes market reactions via a Cholesky factorization into a “current policy surprise” factor and a second “path” factor tied to the wording of the post-meeting statement; the path factor turns out to dominate, accounting for roughly four-fifths of the variance of the year-ahead Eurodollar futures rate (versus about one-fifth for the current-surprise factor) and 68 percent of the variance of the five-year Treasury yield, and the “considerable period” language introduced in August 2003 roughly tripled the ten-year yield’s sensitivity to payroll surprises (from about 4 to about 11 basis points per 100,000 jobs). For quantity/composition effects, a five-factor no-arbitrage affine term-structure VAR (estimated on macro and policy factors, monthly 1982-2004) generates a counterfactual yield-curve benchmark, against which the paper attributes the 1999-2002 Treasury debt buyback with pushing the twenty-year yield from about 20 basis points above to about 80 basis points below the model’s prediction (bootstrap probability under 10 percent), concentrated at the long end with only limited evidence of pass-through to swap spreads at short maturities. Extending the analysis to Japan (110 BOJ decisions since independence in April 1998, two-day windows given data limitations), the paper finds little evidence the BOJ used statements to move near-term policy expectations the way the Fed did, but some evidence that quantitative-easing and current-account-balance-target surprises moved the Nikkei (3-6 percent on several occasions) and that a four-factor term-structure model — adjusted by simulation to respect the ZLB — implies actual JGB yields ran persistently below model predictions after the 1999 zero-interest-rate policy and 2001 quantitative easing, with the gap widening over time. The authors describe their overall evidence as “to some degree indirect,” since the US policy rate never actually fell below roughly 100 basis points during the sample, and caution that the size and reliability of quantity/composition effects remain “quite uncertain” and subject to identification problems (for example, the 2003 “deflation scare” episode overlapping with anticipated Treasury purchases); their bottom-line policy recommendation is that central banks are best off avoiding the ZLB altogether by maintaining an inflation buffer and easing preemptively.

Brian P. Sack | Macro Paper Warehouse

Monetary Policy Alternatives at the Zero Bound: An Empirical Assessment