The Federal Reserve Is Not Very Constrained by the Lower Bound on Nominal Interest Rates Eric T. Swanson University of California, Irvine Symposium on Monetary Policy at the Effective Lower Bound Brookings Institution Sept. 14, 2018

Outline of Talk The Federal Reserve Is Not Very Constrained by the ZLB/ELB Fed Has Additional Monetary Policy Tools Available Throughout 2008-2015, Fed Was Never Very Constrained by the ZLB Risks of Fed Being Constrained by the ELB in the Future Are Typically Overstated

Outline of Talk The Federal Reserve Is Not Very Constrained by the ZLB/ELB: Fed Has Additional Monetary Policy Tools Available Throughout 2008-2015, Fed Was Never Very Constrained by the ZLB Risks of Fed Being Constrained by the ELB in the Future Are Typically Overstated

Forward Guidance: Theory New Keynesian IS Curve: 𝑦 𝑡 = 𝐸 𝑡 𝑦 𝑡+1 − 𝛼 𝑟 𝑡 + 𝜀 𝑡 = −𝛼 𝐸 𝑡 𝑗=0 ∞ 𝑟 𝑡+𝑗 + 𝜀 𝑡 𝑗=0 ∞ 𝑟 𝑡+𝑗 Thus, the ZLB is not a substantial constraint on monetary policy if the central bank can credibly commit to keeping interest rates low in the future: Reifschneider-Williams (2000) Eggertsson-Woodford (2003)

Forward Guidance: Empirical Evidence Gurkaynak, Sack, and Swanson (2005) estimated effects of forward guidance (aka “path factor”) on yield curve: See also: Brand, Buncic, Turunen (2010), D’Amico-Farka (2011), Campbell et al. (2012), Leombroni et al. (2017), Swanson (2018)

LSAPs: Survey of Empirical Estimates source: Williams (2013)

FG and LSAPs vs. Conventional Monetary Policy Swanson (2018) Builds on Gurkaynak, Sack, and Swanson (2005) to separately identify effects of federal funds rate, forward guidance, and LSAPs for every FOMC announcement from 1991–2015

Evidence LSAPs Also Affect Real Lending Rodnyansky and Darmouni (2017) Show via diff-in-diff that U.S. banks that owned more MBS increased business lending in response to Fed’s LSAPs Di Maggio, Kermani, and Palmer (2016) Analyze loan-level mortgage originations in the U.S. during Fed’s LSAP operations Show via diff-in-diff that conforming mortgage originations increased, primarily when Fed purchased MBS Koetter, Podlich, and Wedow (2017) Analyze bank-level, security-by-security data in Germany during the ECB’s SMP operations Show via diff-in-diff that German banks with SMP-eligible securities increased lending

Persistence of LSAP Effects Greenlaw, Hamilton, Harris, and West (2018) argue that high- frequency effects of LSAPs didn’t persist and/or were partially reversed after impact But: Many lower-frequency estimates of LSAP effects are very similar to high-frequency estimates Substantial evidence LSAPs affected quarterly lending Swanson (2018) explicitly studies persistence of high- frequency LSAP effects finds they were completely persistent except for March 2009 “QE1” announcement

Persistence of LSAP Effects source: Swanson (2018)

Outline of Talk The Federal Reserve Is Not Very Constrained by the ZLB/ELB Fed Has Additional Monetary Policy Tools Available Throughout 2008-2015, Fed Was Never Very Constrained by the ZLB Risks of Fed Being Constrained by the ELB in the Future Are Typically Overstated

2-Year Treasury Yield Was Not Very Constrained

Swanson-Williams (2014) Estimate daily-frequency regressions of the form δ = 1 corresponds to normal sensitivity to news δ = 0 corresponds to complete insensitivity to news intermediate values of δ represent partial sensitivity

Swanson-Williams: 5-Yr Treasury Sensitivity

Swanson-Williams: 2-Yr Treasury Sensitivity

Carvalho-Hsu-Nechio (2016) Estimate effects of FOMC communication on different Treasury yields over time using textual analysis Get similar results to Swanson-Williams (2014)

Carvalho-Hsu-Nechio: 2-Yr Treasury Sensitivity

VAR Evidence: No Structural Break around 2008 Wu and Xia (2016) Replace federal funds rate with a shadow federal funds rate in a standard VAR Find no evidence of a structural break around 2008 Debortoli, Gali, and Gambetti (2018) Estimate a simple VAR with time-varying parameters Show that IRFs to technology shocks, demand shocks in the pre-ZLB vs. ZLB periods are virtually the same Both papers interpret lack of a structural break as evidence that forward guidance and LSAPs were close substitutes for changes in the federal funds rate during the ZLB.

Sectoral Evidence Skaperdas (2017) Compares interest-rate-sensitive vs. non-interest-rate- sensitive sectors Interest-sensitive sectors performed about as well relative to non-interest-sensitive sectors after 2009 as after previous recessions Suggests again that forward guidance and LSAPs were close substitutes for changes in the federal funds rate during the ZLB

Outline of Talk The Federal Reserve Is Not Very Constrained by the ZLB/ELB Fed Has Additional Monetary Policy Tools Available Throughout 2008-2015, Fed Was Never Very Constrained by the ZLB Risks of Fed Being Constrained by the ELB in the Future Are Typically Overstated

Negative Interest Rates: Switzerland

Negative Interest Rates: Sweden

Negative Interest Rates: ECB

Risks of Hitting the ELB in the Future The ELB is substantially below zero (–0.75 or –1 percent, based on evidence from Europe) For the ELB to be a significant constraint, it must bind for several quarters: Intuitively, 𝑦 𝑡 = −𝛼 𝐸 𝑡 𝑗=0 ∞ 𝑟 𝑡+𝑗 + 𝜀 𝑡 According to Christiano, Eichenbaum, and Rebelo (2011), the ELB must bind for 8 quarters or more for the effects to be economically significant

Risks of Hitting the ELB in the Future The ELB is substantially below zero (–0.75 or –1 percent, based on evidence from Europe) For the ELB to be a significant constraint, it must bind for several quarters (8 quarters or more, according to CER) Thus, risks of the Fed facing a significant ELB constraint on the federal funds rate in the future are much lower than typical calculations (e.g., Kiley-Roberts 2017) Moreover, even when the federal funds rate is significantly constrained by the ELB, the Fed still can use forward guidance and LSAPs.

Conclusions The Federal Reserve Is Not Very Constrained by the ZLB/ELB Fed Has Additional Monetary Policy Tools Available Throughout 2008-2015, Fed Was Never Very Constrained by the ZLB Risks of Fed Being Constrained by the ELB in the Future Are Typically Overstated (But there are some caveats…)

Conclusions The Federal Reserve Is Not Very Constrained by the ZLB/ELB Fed Has Additional Monetary Policy Tools Available Throughout 2008-2015, Fed Was Never Very Constrained by the ZLB Risks of Fed Being Constrained by the ELB in the Future Are Typically Overstated (But there are some caveats…)

Caveat #1: Limits to Forward Guidance In a very severe ELB scenario, effectiveness of forward guidance will be reduced However, even in that scenario, LSAPs are still available

Caveat #2: Political Constraints LSAPs: Substantial evidence LSAPs lower interest rates and increase bank lending, mortgage originations But LSAPs seem to be poorly understood by the public, evoke strong negative feelings Rick Perry: “almost treasonous” Negative Interest Rates: Evidence from Europe, central banks, academics is cautiously optimistic But negative interest rates are vehemently opposed by banks, Wall Street John Cryan, Deutsch Bank CEO: “fatal consequences” Mohamed El-Erian, Allianz: “an insane experiment” Bill Gross, Janus Capital: “capitalism… cannot function”

Conclusions The Federal Reserve Is Not Very Constrained by the ZLB/ELB Fed Has Additional Monetary Policy Tools Available Throughout 2008-2015, Fed Was Never Very Constrained by the ZLB Risks of Fed Being Constrained by the ELB in the Future Are Typically Overstated (But there are some caveats…)