Product Overview

Unconventional monetary policy has become the norm since the 2008 financial crisis. Central bank balance sheets have swelled and new tools for interest rate control have now emerged. This technical note provides a framework to help students understand the nature of unconventional monetary policy and interpret recent changes in how short-term policy rates are controlled. It can serve as a technical supplement to an event-study case on monetary policy responses to the 2008 financial crisis and/or the COVID-19 pandemic. It would also complement a case on monetary policy in a world with central bank digital currency. Alternatively, it can form the basis of its own tool-building class ahead of such cases.

Learning Objectives

•To model long-term interest rates as averages of current and expected future short-term interest rates plus a term premium (i.e., the augmented expectations hypothesis). •To use the augmented expectations hypothesis to explore how the central bank can affect economic activity with a short-term policy rate (e.g., the Fed Funds Rate, or FFR, in the United States) as well as when unconventional policies (e.g., forward guidance and quantitative easing, or QE) might be appropriate. •To understand the market for reserves in the United States, specifically how the Federal Reserve (Fed) uses conventional open market operations (OMOs) to set the FFR in a market with scarce reserves and how it uses interest on reserves (IOR) and the overnight reverse repurchase (ON RRP) facility to set the FFR in a market with ample reserves. •To connect the need for IOR and ON RRP to successive waves of QE.