Unconventional monetary policies – such as large-scale asset purchases and signalling that the central bank will keep its policy interest rates low – serve to lower longer-term rates and raise share prices. But these effects on financial markets seem to be quite short-lived. These are among the conclusions of research by Professor Jonathan Wright, published in the November 2012 issue of the Economic Journal.

Professor Wright suggests that the short-lived effects could be because markets simply overreact to the initial announcements. More optimistically, it could be because unconventional monetary policy makes the economy stronger than would otherwise have been the case, which causes interest rates to rise over time.

The Federal Reserve and the Bank of England have both driven their policy interest rates close to the zero lower bound in an effort to stimulate economic activity in the aftermath of the Great Recession. Yet this has not been enough: the United States has faced a jobless recovery; and the UK experienced a ”double-dip” recession, from which it has only just emerged.

The Fed and the Bank have accordingly also begun unconventional monetary policies, such as signalling that interest rates will be kept low in the future and, especially, conducting large-scale purchases of government bonds and other securities.

This study employs a novel econometric methodology to assess the effectiveness of the announcements of these unconventional monetary policies on asset prices in the United States.

Professor Wright finds that the policies are indeed effective in lowering a range of longer-term interest rates, including interest rates on corporate bonds and mortgage-backed securities. They also boost share prices.

For example, a monetary policy surprise that lowers ten-year Treasury yields by 0.25% is estimated to reduce corporate bond yields by about 0.15% and to boost share prices by about 1%. Unconventional monetary policy in the United States also lowers government bond yields in other countries.

The research looks only at what monetary policy does to asset prices. But by making it cheaper for businesses and households to borrow and by driving up share prices, the unconventional policies ought to boost economic growth and lower unemployment.

What Does Monetary Policy Do to Long-term Interest Rates at the Zero Lower Bound?” by Jonathan Wright is published in the November 2012 issue of the Economic Journal.

Jonathan Wright

Johns Hopkins University | +1-410-516-5728 | wright@jhu.edu