Atlanta Fed Paper: Unconventional Policy Reduced Unemployment By 0.13%

A new working paper published by the Atlanta Federal Reserve shows the central bank's unconventional monetary policies reduced the unemployment rate by 0.13% from where it otherwise would have been.

Researchers Jing Cynthia Wu and Fan Dora Xia also find that if markets believed policy rates would be held at zero for a year longer than currently expected, the unemployment rate would fall by another 0.25%.

Wu, of the University of Chicago Booth School of Business, and Xia, with the University of California at San Diego, admit "assessing the impact of these measures or summarizing the overall stance of monetary policy in the new environment has proven to be a big challenge."

But using a newly constructed model to measure the impact of the Fed's policies since it reached the zero lower bound, they find the Fed "succeeded in lowering the unemployment rate by 0.13% relative to where it would have been in the absence of these measures.

That means in December 2013, the unemployment rate would have been 6.83%, rather than 6.7% we actually saw, they write in the working paper published by the the Atlanta Fed's Center for Quantitative Economic Research.

The Federal Reserve reduced its policy interest rate to zero at the end of 2008, in response to the financial crisis and recession. Since then, they have been relying on large-scale asset purchases and forward guidance to hold down long term interest rates. In the process, the Fed has purchased more than $3 trillion in Treasuries and agency mortgage backed securities.

Other impacts of the unconventional policies by the Fed since July 2009, according to the working paper: The industrial production index would have been 101.0 rather than 101.8 at the end of December 2013, and capacity utilization would be 0.3% lower than observed. And housing starts would be 11,000 lower, at 988,000 starts vs. the 999,000 annualized rate reported in December.

"These numbers suggest that unconventional monetary policy achieved its goal of stimulating the economy," they write.

But the findings also suggest the unconventional moves by the Fed had less of an impact than suggested in other research, "primarily because (other research) assumed that unconventional monetary policy had a big impact on the yield curve."

Interestingly, though, the Fed's accommodative policy "has not boosted real activities at the cost of high inflation," they point out. "Instead, monetary policy shocks have contributed to decreasing the consumer price index by 1."

Breaking out just the impact of forward guidance on the macroeconomy, Wu and Xia show that a one-year extension of the expected zero-lower bound duration would be similar to a 35 basis-point reduction in the policy rate.

This would mean "capacity utilization goes up by 0.6%, unemployment rate decreases by 0.25% and housing starts is about 5% over its steady state," they said. The researchers also suggest "forward guidance and the market's expectation align well" adding that the market seems to adjust towards the Fed's announcements "ahead of time."

The research uses the shadow rate from the shadow rate term structure model as a measure of monetary policy accommodation to account for the Fed funds rate inability to go past zero to stimulate economic activity.

They say it "exhibits similar dynamic relations to key macro variables before and after the Great Recession, and appears to capture meaningful information missing from the effective federal funds rate after the economy reached the zero lower bound."

Since 2009, the effective federal funds rate has been stuck at the lower bound, "and no longer conveys any information due to its lack of variability," they said.

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