Estimating the macroeconomic effects of the Fed’s asset purchases

Abstract

An analysis shows that the Federal Reserve’s large-scale asset purchases have been effective at reducing the economic costs of the zero lower bound on interest rates. Model simulations indicate that, by 2012, the past and projected expansion of the Fed’s securities holdings since late 2008 will lower the unemployment rate by 1 percentage points relative to what it would have been absent the purchases. The asset purchases also have probably prevented the U.S. economy from falling into deflation. The zero lower bound on nominal interest rates limits the ability of central banks to reduce short-term interest rates. As a result, when nominal interest rates are near zero, central banks are unable to use further reductions in short-term interest rates to provide additional stimulus to the economy and check unwelcome disinflation. With the unemployment rate very high and measures of underlying inflation trending downward, the Federal Reserve’s main policy tool, the federal funds rate, has been at its effective lower bound for over two years now. Participants in futures markets currently expect the federal funds rate to remain near zero until late 2011. Owing to the constraint of the zero lower bound, several major central banks, including the Bank of England and the Bank of Japan, have adopted alternative monetary policy approaches of buying longer-term securities. Similarly, the Fed purchased $1.7 trillion

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