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Unconventional Monetary Policy and the Interest Rate Channel: Signalling and Portfolio Rebalancing

WP Number: 1715

Abstract: In response to financial turmoil that began in 2007 and the effective lower bound for short-term interest rates that was reached in late-2008, the Federal Reserve adopted a raft of 'unconventional' monetary policies, notably: forward guidance and large-scale asset purchases. These policies transmit to the real economy, inter alia, via an interest rate channel, with two sub-channels: signalling and portfolio rebalancing. I apply the OIS-augmented decomposition of interest rates from Lloyd (2017a) to identify these two sub-channels. I demonstrate that US unconventional monetary policy announcements between November 2008 and April 2013 did exert significant signalling and portfolio balance effects on financial markets, reducing longer-term interest rates. Signalling effects were particularly powerful at horizons in excess of two years. As a result of these declines, unconventional monetary policy aided real economic outcomes. I show that the signalling channel exerted a more powerful influence on US industrial production and consumer prices than portfolio rebalancing. In terms of long-term bond yield and industrial production effects, the signalling channel is associated with around two-thirds to three-quarters of the total effects attributed to the two channels.

Keywords: Unconventional Monetary Policy, Large-Scale Asset Purchases, Forward Guidance, Signalling, Portfolio Rebalancing, Interest Rates, Term Structure, Overnight Indexed Swaps

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