A Large-Dimensional Factor Analysis of the Federal Reserve's Large-Scale Asset Purchases

Abstract

This paper assesses the economy-wide effects of US unconventional monetary policy shocks. A precise identification of the unconventional monetary policy shocks is achieved by imposing zero and sign restrictions on a number of impulse responses from a large-dimensional dynamic factor model. In particular, an unconventional expansionary monetary policy shock is identified as a shock that increases the Federal Reserve's market share of US treasuries and mortgage-backed securities, and leads to an improvement in the real economy and improved credit conditions.

I find that an unconventional monetary policy shock significantly drives down the long-term interest rate spread and the credit spread, and improves both the financial market conditions and the commercial and industrial loans activity. Moreover, the impact on the real economy is significant.

The roughly $2 trillion purchases of mortgage backed securities by the Federal Reserve Bank avoided a severe downturn according to estimates from a counterfactual analysis.

Keywords: unconventional monetary policy, zero lower bound, large cross-sections, dynamic factor model, factor-augmented vector autoregression (FAVAR), Expectation-Maximization algorithm

JEL Classification: C32, C55, E43, E52, E58