Special Issue: Federal Reserve System Conference on Monetary Policy - Strategy, Tools, and Communication Practices
Are QE and Conventional Monetary Policy Substitutable?

Eric Sims and Jing Cynthia Wu
Notre Dame and NBER


Yes! We study the substitutability between conventional monetary policy based on the adjustment of a short-term policy interest rate with quantitative easing (QE). We do so in a four-equation New Keynesian model featuring financial frictions that allows QE to be economically relevant. We analytically derive how much QE versus conventional policy is necessary to implement an inflation target. Quantitatively, the observed expansion of the Federal Reserve's balance sheet over the zero lower bound (ZLB) period provides stimulus equivalent to cutting the policy rate to 2 percentage points below zero. This is in line with the decline in the empirical shadow federal funds rate series. Moreover, we show that the amount of QE required to achieve price stability depends on the expected duration of the ZLB.

JEL Code: E32, E52, E58.

Full article (PDF, 36 pages, 755 kb)