Quantitative Easing
and the “New Normal” in Monetary Policy*
Michael T. Kiley
Version 9
January 2, 2018
ABSTRACT
Interest rates may remain low and fall to their effective lower bound (ELB) often.As a result,
quantitative easing (QE), in which central banks expand their balance sheet to lower long-term
interest rates, may complement policy approaches focused on adjustments in short-term interest
rates.Simulation results using a large-scale model (FRB/US) suggest that QE does not improve
economic performance if the steady-state interest rate is high, confirming that such policies were
not advantageous from 1960 to 2007.However, QE can offset a significant portion of the
adverse effects of the ELB when the equilibrium real interest rate is low.These improvements in
economic performance exceed those associated with moderate increases in the inflation target.
Active QE is primarily required when nominal interest rates are near the ELB, pointing to
benefits within the model from QE as a secondary tool while relying on short-term interest rates
as the primary tool.
JEL Codes: E52, E47, E37
Keywords: Monetary Policy, Interest Rates, Macroeconomic Models
ACKNOWLEDGMENTS
Any errors are the sole responsibility of the author. An early draft benefitted from comments by
Dave Reifschneider, Katie Rha, and participants in the Money, Macro, and Finance (MMF) 2017
conference at Kings College, the Central Bank Macro Modelers Workshop 2017 at the Banque
de France, and a workshop at the Federal Reserve Board.
The analysis and conclusions set forth are those of the author and do not indicate
concurrence by the Federal Reserve Board or other members of its staff.
* Contact information: Michael T. Kiley—mkiley@frb.gov.Periods during which short-term nominal interest rates are stuck at their effective lower bound
(ELB) may be more frequent and costly in the future, as nominal interest rates may remain
substantially below the norms of the last fifty years.Using simulations of a large-scale
econometric model and a dynamic-stochastic-general-equilibrium (DSGE) model, Kiley and
Roberts (2017) estimate that the ELB may be encountered 40 percent of the time or more under a
rule for the short-term interest rate of the type emphasized in Taylor (1999) and Yellen (2017).
During recent years, central banks provided accommodation beyond that implied by
adjustments in the short-term nominal interest rates via quantitative easing (QE), in which the
monetary authority purchased long-term bonds by issuing short-term liabilities (e.g., reserves).
In the United States, such efforts began in late 2008.1Analogous programs were instituted by
the Bank of England and European Central Bank (ECB) in the first half of 2009, although the
magnitude of ECB purchases expanded substantially much later.2(Efforts in Japan had begun
much earlier, reflecting the fall to the ELB in Japan by the late 1990s.)Because long-term bonds
and reserves are imperfect substitutes (reflecting market-segmentation, portfolio balance, or
other channels), QE lowered long-term interest rates (e.g., Gagnon et al, 2011; Ihrig et al, 2012).
These declines in long-term interest rates stimulated spending, thereby supporting the economic
recovery and limiting the degree to which inflation fell (e.g., Engen, Laubach, and Reifschneider,
2015).3
Quantitative easing is typically called an unconventional policy measure.The Federal
Reserve has indicated “that changing the target range for the federal funds rate is its primary
1 See Federal Reserve Board (2015).
2 For a discussion of the QE program in the UK, see Joyce, Tong, and Woods (2011); for a review of the early
European experience, see Altavilla, Carbon, and Motto (2015).
3 Vayanos and Vila (2009) discuss market segmentation, and Andrs, Nelson, and Lopez-Salido (2004) embed
related mechanisms in a small DGE model.means of adjusting the stance of monetary policy”, while emphasizing that it “would be prepared
to use its full range of tools, including altering the size and composition of its balance sheet, if
future economic conditions were to warrant a more accommodative monetary policy than can be
achieved solely by reducing the federal funds rate”.4
Research has asked whether unconventional policies should become part of the
conventional toolkit, deployed regularly when recessions or disinflation warrant.5Some of these
analyses are qualitative discussion that focus on the range of arguments offered by policymakers
for or against the use of QE in the future (e.g., Bernanke, 2017).However, analysis of the
systematic effects of alternative strategies for QE, accounting for the ELB, has been limited.For
example, Carlstrom, Fuerst, and Paustian (2016) and Quint and Rabanal (2017) present DSGE
models in which quantitative easing is a powerful instrument for counteracting financial shocks,
but abstract from the interaction of quantitative easing and the ELB.Reifschneider (2016)
considers the effects of QE in an illustrative scenario using the FRB/US model, but does not
consider how a QE strategy interacts with the setting of the short-term interest rate under a wide
variety of conditions or the relative merits of QE and other approaches, such as raising the
inflation target or strategies with price-level, rather than inflation, elements.More recently,
Harrison (2017) analyzes the efficacy of QE strategies in a small New-Keynesian model of the
UK economy.
The analysis herein addresses this gap in the literature using a simulation approach –
similar to that employed by Reifschneider and Williams (2000), Williams (2009), Coibion,
4 These quotes are from the “Addendum to the Policy Normalization Principles and Plans” issued by the Federal
Open Market Committee on June 14, 2017, available at
federalreserve.gov/newsevents/pressreleases/monetary20170614c.htm.
5 For example, Bayoumi et al (2014).。