The Federal Reserve's Unconventional Policies by John C. Williams

Excerpt from

Presentation to the Center for Economics and Public Policy

UC Irvine

Irvine, California

By John C. Williams, President and CEO, Federal Reserve Bank of 

San Francisco

For delivery on November 5, 2012

Download PDF Version (69 MB)

To be precise, the estimated impact of a $600 billion LSAP program, such as QE2, is to lower the 10-year Treasury yield by between 0.15 and 0.20 percentage point.16 It is around the same magnitude as the effects of forward policy guidance, and about how much the yield on 10-year Treasury securities typically responds to a cut in the fed funds rate of three-quarters to one percentage point.17 So, by that metric, LSAPs have big effects on longer-term Treasury yields.

By pushing down longer-term Treasury yields, forward guidance and LSAPs have rippled through to other interest rates and boosted other asset prices, lifting spending and the economy. For example, mortgage rates have fallen below 3½ percent, apparently the lowest level since at least the 1930s. Thanks in part to those rock-bottom rates, we’re at long last seeing signs of life in the housing market. Likewise, cheap auto financing rates have spurred car sales. And historically low corporate bond rates encourage businesses to start new projects and hire more workers.
In addition, low interest rates help to support asset prices, such as the value of people’s homes and their retirement funds. All else equal, households are more likely to consume if their wealth is growing rather than falling. Stronger asset prices support consumption because they make people feel wealthier and more confident. And that in turn helps boost the economy.
Finally, although it’s not our main intention, these unconventional policies have also had an effect on the dollar versus foreign currencies. When interest rates in the United States fall relative to rates in other countries, the dollar tends to decline as money flows to foreign markets with higher returns. One estimate is that a $600 billion program like QE2 causes the dollar to fall by roughly 3 or 4 percent.18 That helps stimulate the U.S. economy by making American goods more competitive at home and abroad.
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We estimated that the Fed’s $600 billion QE2 program lowered the unemployment rate by about 0.3 percentage point compared with what it would have been without the program. We also estimated that the program raised GDP by a little over half a percentage point and inflation by 0.2 percentage point. When we considered the combined effects of QE1 and QE2, we found that these programs had a peak effect of reducing the unemployment rate by 1½ percentage points. In addition, we found that these programs probably prevented the U.S. economy from falling into deflation.