The efficacy of large-scale asset purchases at the zero lower bound
Economic Review, 2010, vol. 95, issue Q II, 5-34
During the recent financial crisis, the Federal Reserve took unprecedented actions to prevent the economy from collapsing. First, the Federal Open Market Committee (FOMC) lowered the short-term federal funds rate nearly to its zero lower bound. Then, several months later, the FOMC began making large-scale purchases of long-term Treasury bonds to lower long-term interest rates by reducing the supply of long-term assets. The FOMC?s announcement of its intent led to immediate and substantial declines in the yields of long-term Treasury bonds, but some observers questioned whether such purchases could really lower long-term interest rates. ; Doh uses a preferred-habitat model that explicitly considers the zero bound for nominal interest rates. His analysis suggests that purchasing assets on a large scale can effectively lower long-term interest rates. Furthermore, when heightened risk aversion disrupts the activities of arbitrageurs, policymakers may lower long-term rates more effectively through asset purchases than through communicating their intentions to lower the expected path of future short-term rates.
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