Without the extraordinary interventions of the Federal Reserve in the immediate aftermath of the financial crisis of 2008, the US economy would have a faced a deeper and more protracted recession.

That is the central finding of research to be presented at the Royal Economic Society”s annual conference at the University of Sussex in Brighton in March 2018.

Analysis by Jagjit Chadha, Luisa Corrado, Jack Meaning and Tobias Schuler suggests that the Federal Reserve”s decision to undertake quantitative easing supported nominal GDP by some 3½ percentage points and might have prevented a rise in unemployment of some 2 percentage points.

When the crisis struck, falling asset prices, increased risk premia and a heightened demand for liquidity led to the cost of credit rising and the supply of new lending weakening significantly. The authors model this process and investigate a range of policy responses.

They find that when central banks injected reserves into the banking sector, this met the increased demand from commercial banks for safe, liquid assets and helped support lending to the real economy. Furthermore, by undertaking ”quantitative easing” – where they buy assets and pay with newly created money – the central bank can boost asset prices and support credit by directly creating new deposits.

When applied to a simulation that approximates the Global Financial Crisis, the model suggests the actions of the Federal Reserve helped the US economy avoid a significantly worse economic outcome than would otherwise have been the case. Without the policy interventions, the recovery would have taken roughly twice as long.

Simulations by the authors also suggest that quantitative easing policies, if carried out quickly and in sufficient magnitudes, can significantly insulate the real economy from an extreme economic shock, even when the Federal Reserve”s primary instrument of policy – the Fed Funds Rate – is constrained at the lower zero bound.

Finally, the model matches the observed behaviour in monetary aggregates, providing an explanation for why the ”money multiplier” – the ratio of broad money to central bank money – fell so dramatically over this period. This is a key contribution as it provides a deeper understanding of the role of different forms of money in the economy.

Professor Jagjit Chadha

020 7222 7665 | J.Chadha@niesr.ac.uk

Professor Luisa Corrado

+39-3458885462 | luisa.corrado@uniroma2.it

Dr Jack Meaning

07595-632493 | Jack.Meaning@bankofengland.co.uk

Dr Tobias Schuler

+49-15751337371 | tobias.schuler@gmail.com