The Non-linear Effects of the Fed's Asset Purchases

The Federal Reserve responded to the global financial crisis of 2008 with the deployment of new monetary policy tools, the most notable of them being the expansion of its balance sheet. In a recent paper, Weale and Wiladeck (2016) show that the asset purchases were effective in stimulating economic activity, inflation and asset prices. In this paper, we show that the results of asset purchases are state-dependent: large scale purchases are effective only when financial markets are impaired. Using an estimated threshold vector autoregressive model conditional on the volatility regime, we show that an increase in the balance sheet has expansionary effects on GPD and inflation when volatility is high, but not when it is low (in which case its effects become mostly insignificant). We argue that high volatility can be interpreted as a proxy of market dysfunction, and therefore only when this transmission channel is active is unconventional monetary policy particularly effective. This suggest that models of transmission mechanisms of unconventional policies that are based on asset purchases should focus more on the market functioning channel and not only on the portfolio rebalance channel.