IMF Working Papers

Unconventional Monetary Policy and Long-Term Interest Rates

Author/Editor:

Tao Wu

Publication Date:

October 22, 2014

Electronic Access:

Free Download. Use the free Adobe Acrobat Reader to view this PDF file

Summary:

This paper examines the transmission mechanism through which unconventional monetary policy affects long-term interest rates. I construct a real-time measure summarizing market projections of the magnitude and duration of the Federal Reserve's Large Scale Asset Purchases (LSAP) program, and analyze the determination of term premiums and expectations of future short-term interest rates in a sample spanning more than two decades. Empirical findings suggest that the LSAP has effectively lowered the long-term Treasury bond yields, through both "signaling" and "portfolio balance" channels. On the other hand, the Fed's "forward guidance" also leads to gradual extension of market projections for the duration of the LSAP program, thereby enhancing the LSAP's effect to keep term premiums low. Estimation results also reveal a diminished effectiveness of the LSAP during QE III. Finally, model simulations underscore the importance of policy transparency in minimizing unnecessary market turbulence and ensuring a timely and smooth exit of the unconventional monetary policy stimulus.

Series:

Working Paper No. 2014/189

Subject:

Financial institutions Financial services Futures Long term interest rates Monetary policy Short term interest rates Unconventional monetary policies Yield curve