Unconventional Monetary Policy

Unconventional Monetary Policy refers to actions taken by the Federal Reserve that are outside of its standard toolkit. This section outlines the many different policy responses by the Federal Reserve since March 2020. Many of these policies were used during the Great Recession. When they were, we briefly compare today's response with the response then.

Before digging in, we remind the reader that while the Fed has offered a large amount of funds to various financial institutions distressed by the coronavirus crisis, in reality, only a fraction of the funds have been used. Moreover, while each of the following policies targets a specific market or financial actor in the financial sector, the Fed oftentimes has as its ultimate goal the support of non-financial firms and/or households.

What is the Policy Response to the Coronavirus Crisis?

Quantitative easing refers to the central bank expanding the money supply by buying assets, typically longer-dated government securities. It is the most common form of unconventional monetary policy, and is typically only resorted to once interest rates have reached the zero lower bound. By purchasing long-dated assets, the Fed is in a sense increasing demand for such securities and, in turn, driving up their price.

This process has two effects. First, through a credit channel, there is more liquidity in the financial system. Increased liquidity makes it easier for banks and other financial intermediaries to make loans. Second, there is a portfolio rebalancing channel. By lowering the yield on safe, long-dated securities, investors may tilt their portfolio towards riskier assets, such as corporate securities, which would tend to ease financial constraints faced by the corporate sector. For more details on these two channels, see Krishnamurthy and Vissing-Jorgensen (2011).

Federal Reserve Balance Sheet - Assets

By the end of October 2014, the Fed was no longer buying new assets and was trying to shrink its balance sheet. The size of the balance sheet began falling in late-2017 as assets began to "roll off" its balance sheet. In other words, the Fed was letting them mature without reinvesting the proceeds. In September 2019, following disruptions in the repo market, the Fed began investing a portion of the principal repayments into treasury securities and agency debt.

On March 15, 2020, in the FOMC statement the Fed announced purchases of at least $500 billion in treasury securities and$200 billion in agency mortgage-backed securities over the next few months. On March 23, 2020, they included agency commercial mortgage-backed securities in its expected purchases.

What is the Historical Precedent?

Quantitative easing was first used in Japan in 2001. It was mostly a Japanese phenomenon until the Great Recession, when policy rates for central banks around the world hit zero. In the United States, there were many rounds of Quantitative Easing, or Large Scale Asset Purchases, during the Great Recession. All told, the Fed's balance sheet increased from around $800 billion to over$4 trillion. This increase was due to purchases of agency MBS (mostly held by Fannie Mae, Freddie Mac, and Ginnie Mae) and long-term treasury securities