Interpreting the Unconventional U.S. Monetary Policy of 2007-09

This paper reviews the unconventional U.S. monetary policy responses to the \u85nan-cial and real crises of 2007-09. It catalogues these policies into three groups: interest-rate policy, quantitative policy, and credit policy. To interpret interest-rate policy, it compares the Federal Reserves actions with the literature on optimal policy in a liquid-ity trap. This comparison suggests that policy has been in the direction suggested by theory, but it has not gone far enough. To interpret quantitative policy, it reviews the determination of ination under di¤erent policy regimes. The main danger for ination coming from the current actions is that the Federal Reserve may lose its independence in choosing monetary policies, while a bene\u85cial side-e¤ect of the crisis is that the Fried-man rule can be implemented by paying interest on reserves. To interpret credit policy, it presents a new model of capital market imperfections and their interaction with real investment decisions with di¤erent \u85nancial institutions and a role for legacy assets, mark-to-market, and leverage. The model suggests that providing credit to traders in securities markets is a more e¤ective response to a \u85nancial crisis than it is to extend credit to the originators of loans