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Briefing
Large Excess Reserves and the Relationship between Money and Prices
As a consequence of the Federal Reserve's response to the financial crisis of 2007?08 and the Great Recession, the supply of reserves in the U.S. banking system increased dramatically. Historically, over long horizons, money and prices have been closely tied together, but over the past decade, prices have risen only modestly while base money (reserves plus currency) has grown substantially. A macroeconomic model helps explain this behavior and suggests some potential limits to the Fed's ability to increase the size of its balance sheet indefinitely while remaining consistent with its ...
Working Paper
Quantitative Easing and the “New Normal” in Monetary Policy
Interest rates may remain low and fall to their effective lower bound (ELB) often. As a result, quantitative easing (QE), in which central banks expand their balance sheet to lower long-term interest rates, may complement policy approaches focused on adjustments in short-term interest rates. Simulation results using a large-scale model (FRB/US) suggest that QE does not improve economic performance if the steady-state interest rate is high, confirming that such policies were not advantageous from 1960 to 2007. However, QE can offset a significant portion of the adverse effects of the ELB when ...
Working Paper
A Currency Premium Puzzle
Standard asset pricing models reconcile high equity premia with smooth risk-free rates by inducing an inverse functional relationship between the mean and the variance of the stochastic discount factor. This highly successful resolution to closed-economy asset pricing puzzles is fundamentally problematic when applied to open economies: It requires that differences in currency returns arise almost exclusively from predictable appreciations, not from interest rate differentials. In the data, by contrast, exchange rates are largely unpredictable, and currency returns arise from persistent ...
Discussion Paper
Are Financial Markets Good Predictors of R‑Star?
Recently, there has been renewed attention on the natural rate of interest—often referred to as “r-star”—and whether it has risen from the historically low levels that prevailed before the COVID-19 pandemic. The natural interest rate is the real (inflation-adjusted) interest rate expected to prevail when supply and demand in the economy are in balance and inflation is stable. Some commentators claim that the prior decline in r‑star has reversed, pointing to the recent rise in future real interest rates implied by the bond market. But before declaring the death of this “low ...