What does Monetary Policy do to Long-Term

Interest Rates at the Zero Lower Bound?

Jonathan H. Wright

First Version: January 22, 2011

This version: December 13, 2011
Abstract
The federal funds rate has been stuck at the zero bound for over two years and
the Fed has turned to unconventional monetary policies, such as large scale
asset purchases to provide stimulus to the economy. This paper uses a structural
VAR with daily data to identify the eects of monetary policy shocks on various
longer-term interest rates during this period. The VAR is identied using the
assumption that monetary policy shocks are heteroskedastic: monetary policy
shocks have especially high variance on days of FOMC meetings and certain
speeches, while there is nothing unusual about these days from the perspective
of any other shocks to the economy. A complementary high-frequency event-
study approach is also used. I nd that stimulative monetary policy shocks
lower Treasury and corporate bond yields, but the eects die o fairly fast,
with an estimated half-life of about two months.
JEL Classication: C22, E43, E58.
Keywords: Monetary policy, Identication, Quantitative easing, Zero lower
bound, Vector Autoregression, Event study.

Department of Economics, Johns Hopkins University, Baltimore MD 21218; [email protected].

I am grateful to Tobias Adrian, Joseph Gagnon, Refet Grkaynak and Eric Swanson for helpful
discussions. All errors are my sole responsibility.
1 Introduction
During the recent nancial crisis, the Federal Reserve sharply lowered the target for
the federal funds rate. In December 2008, the federal funds rate was set to the zero
lower bound (more precisely in a target range from zero to 25 basis points), and
has remained there since then. With monetary policy stuck at the zero bound, the
Federal Open Market Committee (FOMC) began using other, less conventional, ways
to further stimulate aggregate demand. This included statements signaling that the
funds rate would be kept at the zero bound for a long time, programs geared towards
supporting certain critical credit markets that were frozen, such as the Commercial
Paper Funding Facility and the Term Asset-Backed Securities Loan Facility. And it
included providing additional stimulus to the economy by large-scale asset purchases
(LSAPs) of Treasury securities and other high-grade bonds, a policy that is commonly
referred to as quantitative easing. A key motivation for these purchases was to try
to lower the interest rates being paid by households and businesses, so as to support
consumption and investment spending. The rationale put forth by Federal Reserve
ocials mainly relies on a preferred habitat paradigm, as envisioned by Modigliani
and Sutch (1966, 1967) and more recently by Vayanos and Vila (2009) in which
markets are segmented, investors demand bonds of a specic type, and the interest
rate is determined by the supply and demand of bonds of that particular type (Kohn
(2009)). The LSAPs could also work in other ways, such as by aecting agents
expectations of the future course of monetary policy.
Nearly three years after the overnight rate hit the zero bound, there is a rapidly-
growing literature on assessing the eects of the unconventional monetary policies
that have been used over this period. Important contributions include Doh (2010),
DAmico and King (2010), Gagnon et al. (2010), Hamilton and Wu (2010), Neely
1
(2010), Hancock and Passmore (2011) and Krishnamurthy and Vissing-Jorgenson
(2011). Also, Swanson (2011) reexamined Operation Twist from the 1960s using an
event-study perspective, and compared it to the unconventional monetary policies
presently being employed by the Federal Reserve.
Measuring the eects of monetary policy shocks in this environment however poses
special challenges. In normal times, the federal funds rate measures the stance of
monetary policy. But things are murkier at the zero bound. There isnt as clean a
single measure of the overall stance of unconventional monetary policy. And while one
could proxy the stance of monetary policy by the size of the Feds balance sheet, with
forward-looking nancial markets, one would expect a policy of asset purchases to
impact asset prices not at the time that the purchases are actually made, but rather
at the time that investors learn that they will take place. LSAPs are announced ahead
of time, in the statements that follow FOMC meetings. These statements are in turn
anticipated to some extent by investors, whose expectations have been guided by
speeches and other comments by FOMC members. Furthermore, whereas the federal
funds futures market gives a fairly clear measure of investors real-time expectations
for changes in the target federal funds rate, there is no such measure of expectations
of the size of LSAPs.
In this paper, I propose measuring the eects of monetary policy shocks during
this period of unconventional monetary policy using a structural vector autoregression
(VAR) in nancial variables at the daily frequency, employing the methodology of
Rigobon (2003) and Rigobon and Sack (2003, 2004, 2005). The idea is to identify
days on which the variance of monetary policy shocks was especially high, during the
period when the federal funds rate was stuck at the zero bound and unconventional
approaches monetary policy were being deployed. These are days of FOMC meetings
and days with other announcements that apparently altered investors views about the
2
likely extent of monetary policy actions. Comparing the variance-covariance matrix
of VAR innovations on these and other days enables identication of the eects of
these monetary policy shocks. In principle, this goes back to the idea of measuring
monetary policy shocks in a VAR of Sims (1980), Bernanke (1986) and Christiano,
Eichenbaum and Evans (1996), but it does so without tying monetary policy decisions
to the level of the target federal funds rates. But unlike the earlier VAR literature,
identication does not depend on the standard short-run zero restrictions. Instead,
this is an identication strategy using heteroskedasticity in daily-frequency data.
It should be emphasized that this approach addresses a somewhat dierent ques-
tion from the analysis of the eects of LSAPs by Gagnon et al. (2010), Krishnamurthy
and Vissing-Jorgenson (2011) and other authors. My approach here identies policy
shocks from the total eect of FOMC-related news on a set of asset prices during
this period of unconventional monetary policy. FOMC statements could impact asset
prices via LSAPsLSAPs are surely the dominant tool of monetary policy when the
economy is stuck at the zero bound. But FOMC statements could also work in other
ways, such as by signaling that the federal funds rate will be kept low (over and above
the signaling eect of LSAPs), or even by changing agents beliefs about the under-
lying state of the economy (if they think that the Fed has some private information).
The proposed methodology measures the total eects of FOMC news and cannot dis-
entangle the eects of these dierent channels. Of course, the separate identication
of the eects of dierent FOMC statements is an important question. Nonetheless,
the structural VAR approach considered here brings some important advantages. It
circumvents the diculties in measuring market expectations for Fed statementsit
isnt necessary to specify what the markets learned from Fed statements, it is only
necessary to specify the times at which a signicant news came out, a much easier
task. It allows for the possibility that other shocks occurred on the same days as
3
the monetary policy shocks. And it provides an estimate of the persistence of the
monetary policy shocks, which the standard event-study methodology cannot do.
Over the period since November 2008, I estimate that monetary policy shocks
have a signicant eect on ten-year yields and long-maturity corporate bond yields
that wear o over the next few months. The eect on two-year Treasury yields is very
small. The initial eect on corporate bond yields is a bit more than half as large as
the eect on ten-year Treasury yields. This nding is important as it shows that the
news about purchases of Treasury securities had eects that were not limited to the
Treasury yield curve. That is, the monetary policy shocks not only impacted Treasury
rates, but were also transmitted to private yields which have a more direct bearing
on economic activity. There is slight evidence of a rotation in breakeven rates from
Treasury Ination Protected Securities (TIPS), with short-term breakevens rising and
long-term forward breakevens falling.
The plan for the remainder of this paper is as follows. Section 2 discusses the
methodology and the identifying assumptions. Section 3 describes the data and re-
ports the results of the empirical work. Section 4 discusses a closely-related event-
study approach that relates the VAR errors to monetary policy surprises measured
using high-frequency intradaily data in small windows that bracket the announce-
ment times. This alternative methodology ends up giving consistent results, but with
estimates that are somewhat more precise. Section 5 concludes.
2 The Method
I assume that a jx1 vector of yields, 1
t
, has the reduced form VAR representation
(1)1
t
= j +
t
(1)
4
where
t
denote the reduced form forecast errors. I further assume that these reduced
form errors can be related to a set of underlying structural shocks

t
=
p
i=1
1
i
j
i;t
(2)
where j
i;t
is the ith structural shock, 1
i
is a jx1 vector, and the structural shocks
are independent of each other and over time. The parameters (1), j and f1
i
g
p
i=1
are all assumed to be constant.
The monetary policy shock is ordered rst but this is for notational convenience
only. The ordering of variables is irrelevant as a Choleski decomposition will not be
used for identication. The monetary policy shock has mean zero and variance o
2
1
on announcement days, and variance o
2
0
on all other days, while all other structural
shocks are identically distributed with mean zero and variance 1 on all dates. The
identifying assumption is that o
2
0
6= o
2
1
. Put another way, the identifying assumption
is that news about monetary policy comes out in a lumpy manner, and the days on
which it comes out are determined by accident of the calendar; and so the volatility
of other structural shocks should be identical on these and other days. This strategy
of identication through heteroskedasticity was rst proposed by Rigobon (2003) and
applied to asset price data by Rigobon and Sack (2003, 2004, 2005), becoming quite
popular in the identication of structural VARs since then.
Let
0
and
1
denote the variance-covariance matrices of reduced form errors on
non-announcement and announcement days, respectively. Clearly,

1

0
= 1
1
1
0
1
o
2
1
1
1
1
0
1
o
2
0
= 1
1
1
0
1
(o
2
1
o
2
0
) (3)
This allows 1
1
to be identied. Without loss of generality, I adopt the normalization
5
that o
2
1
o
2
0
= 1, as 1
1
1
0
1
and (o
2
1
o
2
0
) are not separately identied. I am seeking only
to identify the eects of monetary policy shocks, not the other structural shocks in
the VAR (j
2
. ...j
p
), therefore imposing further structure on the system is not needed.
The econometric strategy is to estimate the VARand construct the sample variance-
covariance matrices of residuals on non-announcement and announcement days, re-
spectively,
^

0
and
^

1
. Then the parameters in the vector 1
1
can be estimated by
solving the minimum distance problem
^
1
1
= arg min
R
1
[cc/(
^

1

^

0
) cc/(1
1
1
0
1
)]
0
[
^
\
0
+
^
\
1
]
1
[cc/(
^

1

^

0
) cc/(1
1
1
0
1
)]
(4)
where
^
\
0
and
^
\
1
are estimates of the variance-covariance matrices of cc/(
^

0
) and
cc/(
^

1
), respectively. Estimates of the impulse responses can then be traced out.
This leaves the question of statistical inference. Use of the bootstrap may help
to mitigate concerns about statistical inference in a small sample size. I do bootstrap
inference in three parts. First, I want to test the hypothesis that announcement
and non-announcement days are no dierent: that
0
=
1
. I do this using the test
statistic
[cc/(
^

1

^

0
)]
0
[
^
\
0
+
^
\
1
]
1
[cc/(
^

1

^

0
)] (5)
and comparing it to a distribution in which announcement and non-announcement
days are randomly scrambled, so that the two variance-covariance matrices are equal
by construction under the null in the bootstrap samples. Rejection of this null hy-
pothesis means that the identication condition is satised.
Second, I want to conduct inference on the structural impulse responses, given that
they are identied. As the data are persistent, I use the bias-adjusted bootstrap of
Kilian (1998), except that instead of resampling from individual vectors of residuals,
6
I use the stationary bootstrap (Politis and Romano (1994)) to resample blocks of
residuals of expected length of 10 days. This means that the bootstrap should preserve
some of the volatility clustering that is evident in the original data.
1
This allows
condence intervals for the impulse responses to be constructed. This bias adjustment
is also applied to the point estimates.
Finally, this same bootstrap can be used to test the hypothesis that
1

0
=
1
1
1
0
1
, in other words that there is a single monetary policy shock. This is done by
comparing the test statistic
[cc/(
^

1

^

0
) cc/(
^
1
1
^
1
0
1
)]
0
[
^
\
0
+
^
\
1
]
1
[cc/(
^

1

^

0
) cc/(
^
1
1
^
1
0
1
)] (6)
to the distribution from the bias-adjusted bootstrap.
2
3 Data and Results
In the baseline implementation of this method, I use daily data on six dierent interest
rates from the period November 3 2008 to September 30 2011. These are the two- and
ten-year nominal Treasury zero-coupon yields from the data set of Grkaynak, Sack
and Wright (2007), the ve-year TIPS breakeven
3
and the ve-to-ten-year forward
TIPS breakeven, from the data set of Grkaynak, Sack and Wright (2010) and the
Moodys indices of BAA and AAA corporate bond yields (not spreads). A VAR (1)
was tted to these data.
Table 1 shows the list of 28 monetary policy announcement days. The criterion
1
Simply resampling from the residuals in the usual way would however give very similar results.
2
More precisely, if
^

0
,
^

1
,
^
R

1
,
^
V

0
and
^
V

1
denote the bootstrap analogs of
^

0
,
^

1
,
^
R
1
,
^
V
0
and
^
V
1
, respectively, then the bootstrap simulates the distributions of
0
[
^
V

0
+
^
V

1
]
1
where =
vech(
^

1

^

0
) vech(
^
R

1
^
R
0
1
) (vech(
^

1

^

0
) vech(
^
R
1
^
R
0
1
)).
3
This is the spread between a nominal and TIPS bond, also known as ination compensation. It
is inuenced by expected ination, the ination risk premium, and the TIPS liquidity premium.
7
for inclusion in this list is that it be either the day of any FOMC meeting during the
period in which monetary policy was stuck at the zero bound,
4
or the day of another
announcement or speech by Chairman Bernanke that was seen as especially germane
to the prospects for unconventional monetary policy. One might of course include
days of other speeches, or releases of FOMC minutes. I did not do so, because it
is important that the estimation of the variance-covariance matrix on announcement
days is not contaminated with days on which there is only trivial or indirect news
about unconventional monetary policy; that will only blunt the distinction between
the two variance-covariance matrices that is crucial to identication.
The days listed in Table 1 span the rst period of quantitative easing (QE1), during
which time the Fed bought a range of assets including a large volume of mortgage
backed securities, the second period of quantitative easing (QE2), which involved
Treasury purchases alone, and what I refer to as the third period of quantitative easing
(QE3) that included the extension of the maturity of the Feds Treasury holdings as
well as the reinvestment of maturing mortgage backed securities. Within the 28 days
listed in Table 1, 13 of them are days that seem especially importantthey are days
around the start of the rst, second and third phases of quantitative easing. These
especially important announcement days are marked in bold.
The variance-covariance matrix of reduced form errors was then estimated over
the 28 announcement days, and over non-announcement days. The method described
in the previous section was then used to estimate 1
1
, the contemporaneous eects of
a monetary policy shock on yields.
The resulting impulse responses function estimates and 90 percent bootstrap con-
4
December 16, 2008 was included. This was the day of the FOMC meeting at which the funds
rate was set at zero, but the statement also included discussion of LSAPs. The unscheduled FOMC
meeting of May 9, 2010 (after which a statement related to foreign exchange swaps was released) is
not included because it has no direct bearing on domestic monetary policy.
8
dence intervals in this baseline VAR are reported in Figure 1. The identied monetary
policy shock is normalized to lower ten-year yields by 25 basis points instantaneously.
The shock lowers AAA and BAA rates, by about half as much as the drop in ten-
year Treasury yields. These eects tend to wear o over time fairly fastthe impulse
responses on ten-year Treasuries and corporate yields are statistically signicant, but
only for a short time. The half-life of the estimated impulse responses for Treasury and
corporate yields is two or three months. Two-year yields fall, but the eect is mod-
est.
5
Short-term breakeven rates rise slightly, while longer-term forward breakeven
rates fall, but these eects are not statistically signicant. The estimates of the ini-
tial eects are mostly consistent with the evidence from event studies. For example,
Krishnamurthy and Vissing-Jorgenson (2011) found that quantitative easing policies
lower long-term Treasuries and the highest rated corporate bonds, and report some
evidence that breakeven rates rise. They however found that quantitative easing has
negligible eects on BAA rates.
The top panel of Table 2 reports the results of comparing the test statistics in
equations (5) and (6) with their bootstrap p-values in this baseline VAR. The null
hypothesis that the reduced form variance-covariance matrix is the same on announce-
ment and non-announcement days is rejected. The null hypothesis that the dierence
between the two variance-covariance matrices can be factored in the form 1
1
1
0
1
is not
rejected. That indicates that the data can be well characterized by a single monetary
policy shock.
The structural VAR approach measures the monetary policy shock directly from
its eects on interest rates. As noted in the introduction, this has a number of advan-
5
Obviously over this period, monetary policy shocks could have no eect on the federal funds
rate or other very short-term interest rates by construction. But the two-year yield was not at the
zero bound (it averaged 81 basis points over the sample), and so monetary policy surprises could
conceivably have had some eect on this. However, it turns out that the eect is small.
9
tages: expectations do not have to be measured, and dynamic eects can be traced
out. However, it also has a number of limitations. In particular, it is silent on the
relative contribution of dierent aspects of unconventional monetary policy (forward
looking guidance about the federal funds rate, LSAPs etc.). Nevertheless, looking at
the evidence here in conjunction with other studies that have considered the eects of
asset purchases more directly, and also noting that the main eect of monetary policy
shocks during the crisis is on long-term interest rates, while short-term interest rates
are little changed, it seems reasonable to surmise that LSAPs represent an important
component of these identied policy shocks.
3.1 Robustness checks and extensions
This subsection reports the results of three types of extensions and robustness checks.
First, the analysis is redone using the more stringent denition of the announcement
dates (only the announcement days marked in bold in Table 1). This should make the
dierence between policy and non-policy dates starker, potentially helping identica-
tion. Impulse response estimates are shown in Figure 2. The results are quite similar
to those in Figure 1, except that the impulse responses are a little more precisely
estimated in this case.
The second robustness check is for the sample period chosen to estimate the VAR.
The baseline VAR is estimated over a short sample period. A natural alternative is
to consider estimating the reduced form parameters in (1) over the period since
January 1999 (when the TIPS yields are rst available), while continuing to estimate

0
and
1
on non-announcement and announcement days starting in November 2008.
This gives the potential benet of greater eciency, although at the potential cost of
having to impose the same coecients of the VAR in the crisis and pre-crisis periods.
10
The results of this exercise are shown in Figure 3. They are again qualitatively similar
to those shown in Figure 1, but the impulse responses are a little more precisely
estimated.
I also consider an alternative specication for the set of variables included in the
VAR, replacing the corporate bond yields with the yield on current-coupon thirty-
year Fannie Mae mortgage backed securities.
6
The results of this exercise are shown
in Figure 4. The monetary policy shock that lowers ten-year Treasury yields by 25
basis points is estimated to lower MBS rates by about 15 basis points. The eect is
statistically signicant for a couple of months, but the eect again wears o fairly
quickly. This paper does not dierentiate between the rst, second and third phases of
quantitative easing. However, QE1 involved heavy purchases of MBS, whereas QE2
entailed purchases of Treasuries only, while QE3 involved elements of both. It seems
reasonable to surmise that if one were able separately to identify monetary policy
shocks in these subperiods, then the sensitivity of MBS rates would be bigger in QE1
than in QE2.
7
As a nal robustness check, I redo the baseline results except that instead of
estimating the VAR by OLS, I estimate the VAR as the posterior mean using the
Minnesota prior.
8
This imposes shrinkage towards the prior that all the variables
are univariate random walks, and so represents another way to address the potential
concern about the downward bias in VAR estimates of persistence. The results, shown
6
Current coupon securities are benchmark mortgage backed securities (MBS). Naturally one
would be most interested in actual mortgage rates, rather than the yields on MBS, from the perspec-
tive of assessing the ability of monetary policy to support the housing market. However, mortgage
rates are not available at the daily frequency, and so MBS rates are the best available substitute for
use in this paper.
7
In other (not reported) robustness checks, I considered trivariate VARs with two- and ten-year
nominal Treasury yields plus one other interest rate (a breakeven rate, a corporate bond yield, or the
MBS yield). These VARs again gave similar results, though in some cases the condence intervals
were a bit tighter.
8
The Minnesota prior (Doan, Litterman and Sims (1984)) shrinks the VAR towards the series
being independent random walks. In my implementation, the shrinkage parameter is set to 1.
11
in Figure 5, are again broadly similar to those in Figure 1, except that the monetary
policy shock is now estimated to have an eect on corporate yields that is about as
big as the eect on ten-year Treasuries.
Table 2 includes the specication tests of the hypotheses that
0
=
1
and that

0
can be factored into the form 1
1
1
0
1
for the alternative denition of announce-
ment dates, the alternative sample period for estimating (1), the alternative choices
of variables in the VAR, and using the Minnesota prior to estimate the VAR. In all
four cases, the hypothesis that announcement and non-announcement days are equiv-
alent is rejected, while the hypothesis of a single monetary policy shock is accepted.
3.2 Avoiding estimating the VAR
An alternative approach is to avoid estimating a VAR altogether, and instead simply
assume that the expectation of each interest rate on day t is well approximated
by its value on day t 1. This means that the one-step-ahead forecast errors,
t
,
can simply be approximated by 1
t
. The dierence between the variance-covariance
matrix of 1
t
on announcement and non-announcement days can again be factored
as in equation (3), giving estimates of the instantaneous impulse responses of the
monetary policy shock. However, in avoiding estimating a VAR, this approach gives up
on trying to estimate the impulse responses at longer horizons. Indeed this approach
of treating the daily rst dierences as approximate reduced form errors was employed
by Rigobon and Sack (2005).
The results are shown in Table 3. The size of the monetary policy shock is normal-
ized to be one that lowers ten-year Treasury yields by 25 basis points. It generates
causes a small and not quite statistically signicant drop in two-year yields, and
signicantly lowers corporate bond yields. The instantaneous impulse responses are
12
qualitatively similar to those from estimating the VAR by OLS, although the point
estimate of the impact on corporate yields is a bit larger, and close to the point es-
timate when estimating the VAR using the Minnesota prior. This isnt surprising,
since the Minnesota prior shrinks towards the series being random walks.
4 Event-study methodology and intradaily data
Identication through heteroskedasticity collapses to the event-study methodology in
the limiting case that the announcement windows contain only the shocks that we
wish to identifythat is, when the variances of all other shocks are negligible. Thats a
stronger assumption, and is surely not reasonable using daily data, especially over this
turbulent period, but it might be an adequate approximation when high-frequency
intradaily data are used. To consider an event-study methodology, I took quotes on
the front contracts on two-, ve-, ten- and thirty-year bond futures trading on the
Chicago Mercantile Exchange (CME) from Tickdata. Table 1 shows the times of each
of the announcements. The monetary policy shock is computed as the rst principal
component of yield changes
9
from 15 minutes before each of these announcements
to 1 hour and 45 minutes afterwards, re-scaled to have a standard deviation of one,
and signed so that a positive surprise represents falling yields.
10
No macroeconomic
news announcements occurred in any of these windows and so it seems reasonable to
assume that the monetary policy shock was the overwhelming driver of asset prices
in these time periods. Unlike in the event studies of Gagnon et al. (2010) and
9
Yield changes were constructed as returns on the futures contract divided by the duration of
the cheapest-to-deliver security in the deliverable basket.
10
This is a fairly wide window, but results are similar using a tighter window from 15 minutes before
the announcement to 15 minutes afterwards. However, the announcements considered represent the
interpretation of statements and speeches, as opposed to giving information about the numerical
value of the target funds rate. Consequently, it seems natural to allow a relatively wide window for
the market to digest the news.
13
Krishnamurthy and Vissing-Jorgenson (2011), the monetary policy surprises are being
measured directly from intraday changes in asset prices.
The approach here is similar in spirit to that of Grkaynak, Sack and Swanson
(2005). These authors recognized that FOMC statements contained both news about
the current setting of the federal funds rate and about its likely future trajectory.
Following many other papers (going back to Kuttner (2001)), they proposed using
current and next-month federal funds futures quotes to measure the surprise compo-
nent of the setting of the target federal funds ratetheir key innovation was that they
proposed using the orthogonal change in four-quarter-ahead eurodollar futures rates
as an asset-price-based quantication of the separate information in the statement
about the outlook for monetary policy going forward. They called these the target
and path surprises. However, since December 2008, there have been no surprises in the
target federal funds rate, and FOMC statements have done little to monetary policy
expectations over the next few quarters. Under these circumstances, it seems perhaps
more appropriate to use changes in longer-term interest rates as an asset-price-based
quantication of monetary policy surprises during this period of unconventional pol-
icy.
11
This directly resolves the problem faced by event studies such as Gagnon et
al. (2010) and Krishnamurthy and Vissing-Jorgenson (2011) that they did not have
data on market expectations concerning the size of LSAPs.
Table 4 reports the slope coecients from regressions of various yield changes
and asset price returns onto the monetary policy surprises, measured as described
in the previous paragraph, over the 28 days listed in Table 1. The left-hand-side
variables are not limited to the variables considered in the VAR. Note that in these
regressions, whereas the right-hand-side variable is constructed using high-frequency
11
Another option would be to use intradaily changes in longer-term eurodollar futures quotes, but
these are quite illiquid at maturities beyond a year or two, and so the use of Treasury futures is
preferable.
14
intradaily data; the left-hand side variables are daily changes, except for stock index
futures, which are available intradaily.
12
A one standard deviation monetary policy surprise is estimated to lower ten-year
Treasury yields by 12 basis points. For comparison, Grkaynak, Sack and Swanson
(2005) estimated that over a period before monetary policy hit the zero bound, it
would take a 100 basis point surprise cut in the target funds rate to lower ten-year
Treasury yields by about this much. In Table 4, corporate bond yields are estimated
to fall by about 7 basis points (a bit more than half as much as the decline in ten-
year Treasury yields), while two-year Treasury yields again fall only a little. There is
a rotation of TIPS breakevens, with ve-year breakevens rising and ve-to-ten-year
forward breakevens falling. A possible interpretation is that the stronger outlook
for demand boosts the short-to-medium-run ination outlook, but the fact that the
LSAPs are overwhelmingly concentrated in nominal (rather than TIPS) securities has
an osetting eect, pushing longer-term breakevens lower. A one standard deviation
monetary policy surprise is estimated to lower Canadian, UK and German ten-year
government bond yields
13
by one-third to one-half as much as the decline in ten-year
US Treasury yieldsthis indicates that the monetary policy actions have impacted
global expectations for short-term interest rates and/or global risk premia, consistent
with Neely (2010). Rates on current coupon thirty-year Fannie Mae mortgage backed
securities fall about 7 basis points. Stock prices rise; a monetary policy surprise
that lowers ten-year yields by 12 basis points is estimated to boost stock returns
by a bit over half a percentage point
14
. All of these eects are highly statistically
12
These are returns on the S&P futures contract trading on the CME from Tickdata, from 15
minutes before each announcement to 1 hour and 45 minutes afterwards.
13
These are zero-coupon yields obtained at the daily frequency from the websites of the Bank of
Canada, Bank of England and Bundesbank, respectively.
14
For comparison, Bernanke and Kuttner (2005) estimated that, before the zero bound was
reached, an unanticipated 25 basis point surprise reduction of the federal funds rate raised stock
prices by about 1 percent.
15
signicant, even though the left-hand-side variable is measured at the daily frequency
in most cases, and even though the sample size is just 28 observations. The SMB
factor of Fama and French (returns on small stocks less returns on big stocks) is not
signicantly aected, consistent with the nding by some researchers that in recent
decades size does not seem to be a priced risk factor in equity markets any more
15
.
But the monetary policy shock does signicantly increase the HML factor (returns
on value stocks less returns on growth stocks). Perhaps rms with high ratios of book
value to market value are most sensitive to the credit channel of the transmission
mechanism of monetary policy.
I also regressed the estimated reduced form errors from the daily VAR (equation
(1)) onto these monetary policy shocks. The coecients are interpreted as estimates of
1
1
in equation (2), and in conjunction with the estimates of the VAR slope coecients
in (1), this allows the eects of the monetary policy shock on the variables in the
VAR to be traced out.
16
The resulting impulse responses are shown in Figure 6,
along with 90 percent condence intervals, using the bootstrap procedure dened in
section 2.
17
Figure 7 reports the results from the same exercise, but with the more
stringent denition of announcement days (as in Figure 2). Likewise, Figures 8-10
are the analogs of Figures 3-5, but using this event-study approach. The results in
Figures 6-10 are quite similar to those from Figure 1-5, but the condence intervals
are generally a lot tighter.
18
The monetary policy shock is estimated to lower long-
15
See, for example, Amihud (2002).
16
The idea of identifying a VAR using an auxiliary dataset at higher frequency than the VAR
observations was proposed in other contexts by Faust, Swanson and Wright (2004) and Bernanke
and Kuttner (2005).
17
The bootstrap also resamples the intradaily monetary policy surprisesfor each bootstrap resid-
ual corresponding to an announcement day, I take the intradaily monetary policy surprise for that
day. The set of bootstrap residuals are regressed on the set of bootstrap monetary policy surprises
to obtain the bootstrap estimate of R
1
.
18
Note that the impulse responses at horizon 0 in Figures 6-10 give the estimates of R
1
: These
are not quite the same as the estimates reported in Table 4. The parameters in R
1
are estimated
by regressing the reduced form errors in the VAR on the monetary policy shocks; Table 4 instead
16
term Treasury and corporate bond yields, with the eect wearing o over time but
remaining statistically signicant for a few months. The half-life of the estimated
impulse responses is two or three months. The eect on two-year Treasury yields
is again small. Short-term breakevens rise, and long-term forward breakevens fall,
perhaps for the reasons discussed above, with these eects being on the borderline of
statistically signicance.
Table 5 shows the monetary policy surprises for each announcement day, esti-
mated using high-frequency intradaily data, as proposed in this section. The state-
ment accompanying the March 2009 FOMC meeting (indicating heavy asset pur-
chases) corresponds to nearly a 4 standard deviation monetary policy surprise. The
estimates in Figures 6-10 would suggest that this lowered ten-year Treasury yields
by roughly 50 basis points on impact. Krishnamurthy and Vissing-Jorgenson (2011)
consider that the statements accompanying the August, September and November
2010 FOMC meetings collectively revealed the essence of the information about QE2.
Much information about QE2 came out at times other than these FOMC meetings
19
and so I would be skeptical of simply adding up the responses to these particular three
events to attempt to measure the total eect of this particular monetary program.
If one does so anyway, the three FOMC announcements sum up to a 1.3 standard
deviation surprise. The estimates in Figures 6-10 indicate that a 1.3 standard devia-
tion monetary policy surprise should lower ten-year Treasury yields by about 15 basis
points on impact.
Of course, judging by the impulse responses in this paper, all these eects wore
regresses daily (or intradaily) returns or yield changes on those monetary policy shocks. However,
the estimates of R
1
and the estimates reported in Table 4 are fairly close.
19
For example, the Fed was reported to have sent a survey to primary dealers asking them to
estimate the size of QE2 in late October 2010. The survey form supplied three options: $250 billion,
$500 billion and $1 trillion. The very fact of setting up the survey question in this way was a signal
that dealers surely did not miss.
17
o over the subsequent months.
5 Conclusions
In response to the nancial crisis and the ensuing deep recession, the Federal Reserve
pushed the federal funds rate to the zero lower bound and began engaging in unortho-
dox monetary policies, notably large-scale asset purchases. This paper has proposed
using the tools of identication through heteroksedasticity and high-frequency event-
study analysis to measure the eects of monetary policy shocks on the conguration
of interest rates when the conventional tool of monetary policy is stuck at the zero
bound. Monetary policy shocks are estimated to have eects on both long-term Trea-
sury and corporate bond yields that are generally statistically signicant, with the
eects fading fairly fast over the subsequent months.
The VAR does not measure eects of shocks on low-frequency macroeconomic ag-
gregates. But having estimates of the eects of monetary policy shocks on asset prices
may be helpful for exercises calibrating the impact of these shocks within macroceo-
nomic models. For example, Chung et al. (2011) simulated the eect of QE2 in the
Federal Reserves FRB/US model. Their simulation assumed that QE2 lowered Trea-
sury term premia by 25 basis points, but had no direct eect on spreads of corporate
and mortgage rates over their Treasury counterparts. Meanwhile, in FRB/US, the
stronger economic outlook induced by lower term premia endogenously causes corpo-
rate and mortgage rates to fall by more than the drop in Treasury yields. The evidence
in the present paper would suggest that Chung et al. overstates the support to ag-
gregate demand because I nd that monetary policy surprises had smaller eects on
private sector rates than on Treasury yields. Also, I nd that the eects of the policy
shocks wear o faster than Chung et al. assumed. To the extent that longer term
18
interest rates are important for aggregate demand, unconventional monetary policy
at the zero bound has had a stimulative eect on the economy, but it may have been
quite modest.
19
Table 1: Dates of Monetary Policy Announcements at the Zero Bound
Date Event Time
11/25/2008 Fed Announces Purchases of MBS and Agency Bonds 08:15
12/1/2008 Bernanke states Treasuries may be purchased 13:45
12/16/2008 FOMC Meeting 14:15
1/28/2009 FOMC Meeting 14:15
3/18/2009 FOMC Meeting 14:15
4/29/2009 FOMC Meeting 14:15
6/24/2009 FOMC Meeting 14:15
8/12/2009 FOMC Meeting 14:15
9/23/2009 FOMC Meeting 14:15
11/4/2009 FOMC Meeting 14:15
12/16/2009 FOMC Meeting 14:15
1/27/2010 FOMC Meeting 14:15
3/16/2010 FOMC Meeting 14:15
4/28/2010 FOMC Meeting 14:15
6/23/2010 FOMC Meeting 14:15
8/10/2010 FOMC Meeting 14:15
8/27/2010 Bernanke Speech at Jackson Hole 10:00
9/21/2010 FOMC Meeting 14:15
10/15/2010 Bernanke Speech at Boston Fed 08:15
11/3/2010 FOMC Meeting 14:15
12/14/2010 FOMC Meeting 14:15
1/26/2011 FOMC Meeting 14:15
3/15/2011 FOMC Meeting 14:15
4/27/2011 FOMC Meeting 12:30
6/2/2011 FOMC Meeting 12:30
8/9/2011 FOMC Meeting 14:15
8/26/2011 Bernanke Speech at Jackson Hole 10:00
9/21/2011 FOMC Meeting 14:15
Notes: This Table lists the days that are treated as announcement days for the
identication strategy considered in this paper. It consists of all FOMC meetings
during the period when the federal funds rate is stuck at the zero bound, and the
days of certain important speeches and announcements concerning large-scale asset
purchases. Announcement days that are treated as especially important are marked
in bold. Times are in all cases Eastern time.
20
Table 2: Specication tests
Hypothesis Wald Statistic Bootstrap p-value
Baseline VAR: All Announcement Days

0
=
1
67.9 0.005

1

0
= 1
1
1
0
1
32.7 0.852
Baseline VAR: 13 Most Important Announcement Days

0
=
1
146.8 0.000

1

0
= 1
1
1
0
1
112.6 0.519
Baseline VAR: Longer Estimation Period

0
=
1
72.7 0.001

1

0
= 1
1
1
0
1
40.7 0.583
Alternative VAR with MBS rates

0
=
1
57.7 0.005

1

0
= 1
1
1
0
1
30.8 0.383
Alternative VAR with CDS-based corporate yield

0
=
1
67.8 0.005

1

0
= 1
1
1
0
1
33.2 0.568
Notes: This table reports the results of specication tests of the hypotheses that
the variance-covariance matrix of reduced form errors is the same on announcement
and non-announcement days, and that there is a one-dimensional structural shock
that characterizes the dierence between these two sets of days. Bootstrap p-values,
constructed as described in the text, are included in both cases. Results are shown
both for the cases where all days listed in Table 1 are treated as announcement days,
and for cases where only the 13 most important days, listed in bold in Table 1, are
treated as announcement days.
21
Table 3: Estimates of the instantaneous eects of monetary policy surprises from
one-day changes in interest rates
Estimate Condence Interval
Ten-year Treasuries -0.25 -0.25 -0.25
Two-year Treasuries -0.04 -0.16 0.01
Five-year Breakevens -0.01 -0.10 0.13
Five-to-ten year forward breakevens -0.15 -0.20 0.14
AAA Yields -0.27 -0.36 -0.07
BAA Yields -0.27 -0.38 -0.07
Notes: This table reports the instantaneous eects of monetary policy surprises tak-
ing one day changes in interest rates as the reduced form forecast errors in the sys-
tem consisting of two- and ten-year Treasury yields, ve and ve-to-ten-year forward
breakevens and AAA and BAA yields. The variance-covariance matrices of these one-
day changes are computed on announcement and non-announcement days, and are
then used to infer the instanantaneous impulse responses.
22
Table 4: Coecients in regressions of yield changes and returns on intradaily
monetary policy surprises
Slope Coecient Standard Error R-squared
AAA Yields -0.073

0.011 44.6
BAA Yields -0.073

0.009 48.2
Two-year Treasuries -0.062

0.006 77.3
Ten-year Treasuries -0.123

0.016 71.6
Five-year Breakevens 0.013

0.006 9.1
Five-to-ten year forward breakevens -0.028

0.010 18.8
Ten-year Canadian Yields -0.056

0.006 49.8
Ten-Year UK Yields -0.043

0.016 35.9
Ten-Year German Yields -0.036

0.008 30.1
Fannie Mae MBS Yield -0.071

0.022 32.0
SMB returns -0.050 0.099 0.7
HML returns 0.434

0.205 15.7
S&P returns 0.549

0.190 21.9
Notes: This table reports the reports the results of daily yield changes or returns
(intradaily for the case of the S&P futures returns) onto the monetary policy surprise,
measured from high-frequency changes in Treasury futures, as described in the text.
The regression is run over the 28 announcement days listed in Table 1. The standard
errors are heteroskedasticity-robust. One, two and three asterisks denote signicance
at the 10, 5 and 1 percent levels, respectively.
23
Table 5: Monetary Policy Surprises at the Zero Bound
Date Policy Surprise
11/25/2008 0.85
12/1/2008 0.96
12/16/2008 2.54
1/28/2009 -0.26
3/18/2009 3.89
4/29/2009 -0.60
6/24/2009 -1.07
8/12/2009 0.18
9/23/2009 0.98
11/4/2009 0.14
12/16/2009 -0.27
1/27/2010 -0.60
3/16/2010 0.43
4/28/2010 0.06
6/23/2010 0.24
8/10/2010 0.66
8/27/2010 -0.95
9/21/2010 0.70
10/15/2010 -0.24
11/3/2010 -0.05
12/14/2010 -0.39
1/26/2011 0.05
3/15/2011 -0.48
4/27/2011 0.24
6/2/2011 -0.35
8/9/2011 1.07
8/26/2011 -0.12
9/21/2011 0.17
Notes: This table shows the monetary policy surprises, estimated as the rst prin-
cipal component of intradaily changes in yields on Treasury futures contracts on all
announcement days, as described in section 4. The surprises are normalized to have a
unit standard deviation and signed so that a positive number represents falling yields.
24
Figure 1: Estimated Impulse Responses in Baseline VAR
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
10 Year Treasury
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
2 Year Treasury
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
5 Year Breakeven
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
5-10 Year Breakeven
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
BAA Yields
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
AAA Yields
Note: Estimates of the impulse responses from monetary policy shocks onto the 6
variables in the system, from 0 to 250 days. 90 percent bootstrap condence intervals
are also shown, constructed as described in the text. The monetary policy shock is
normalized to lower ten-year yields by 25 basis points.
25
Figure 2: Estimated Impulse Responses Using only 13 Announcement Days
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
10 Year Treasury
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
2 Year Treasury
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
5 Year Breakeven
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
5-10 Year Breakeven
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
BAA Yields
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
AAA Yields
Note: As for Figure 1, except that only the 13 days highlighted in bold in Table 1 are
treated as announcement days.
26
Figure 3: Estimated Impulse Responses Using Longer Sample to Estimate VAR
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
10 Year Treasury
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
2 Year Treasury
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
5 Year Breakeven
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
5-10 Year Breakeven
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
BAA Yields
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
AAA Yields
Note: As for Figure 1, except that the reduced form VAR was estimated over the period
since Janaury 1999, as described in the text.
27
Figure 4: Estimated Impulse Responses Using Alternative VAR with MBS Rates
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
10 Year Treasury
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
2 Year Treasury
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
5 Year Breakeven
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
5-10 Year Breakeven
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
MBS
Note: As for Figure 1, except that the reduced form VAR included Fannie Mae current
coupon MBS yields instead of corporate bond rates.
28
Figure 5: Estimated Impulse Responses Using Minnesota Prior
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
10 Year Treasury
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
2 Year Treasury
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
5 Year Breakeven
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
5-10 Year Breakeven
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
BAA Yields
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
AAA Yields
Note: As for Figure 1, except that the reduced form VAR is estimated as the posterior
mean corresponding to the Minnesota prior of Doan, Litterman and Sims (1984) with a
shrinkage parameter of 1.
29
Figure 6: Estimated Impulse Responses in Baseline VAR using Event-Study Identication
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
10 Year Treasury
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
2 Year Treasury
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
5 Year Breakeven
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
5-10 Year Breakeven
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
BAA Yields
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
AAA Yields
Note: Estimates of the impulse responses from regressing monetary policy shocks onto
the 6 variables in the system, from 0 to 250 days. The monetary policy shocks were
identied as the rst principal component of changes in bond futures quotes in intraday
windows around the events listed in Table 1. The reduced form VAR errors were then
regressed onto these monetary policy shocks and the impulse responses were computed
as described in the text. 90 percent bootstrap condence intervals are also shown.
30
Figure 7: Estimated Impulse Responses Using only 13 Announcement Days and Event-Study
Identication
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
10 Year Treasury
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
2 Year Treasury
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
5 Year Breakeven
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
5-10 Year Breakeven
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
BAA Yields
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
AAA Yields
Note: As for Figure 6, except that only the 13 days highlighted in bold in Table 1 are
treated as announcement days.
31
Figure 8: Estimated Impulse Responses Using Longer Sample to Estimate VAR and Event-
Study Identication
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
10 Year Treasury
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
2 Year Treasury
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
5 Year Breakeven
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
5-10 Year Breakeven
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
BAA Yields
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
AAA Yields
Note: As for Figure 6, except that the reduced form VAR was estimated over the period
since Janaury 1999, as described in the text.
32
Figure 9: Estimated Impulse Responses Using Event-Study Identication in Alternative VAR
with MBS Rates
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
10 Year Treasury
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
2 Year Treasury
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
5 Year Breakeven
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
5-10 Year Breakeven
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
MBS
Note: As for Figure 6, except that the reduced form VAR included Fannie Mae current
coupon MBS yields instead of corporate bond rates.
33
Figure 10: Estimated Impulse Responses Using Minnesota Prior
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
10 Year Treasury
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
2 Year Treasury
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
5 Year Breakeven
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
5-10 Year Breakeven
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
BAA Yields
0 50 100 150 200 250
-0.2
-0.1
0
0.1
0.2
AAA Yields
Note: As for Figure 6, except that the reduced form VAR is estimated as the posterior
mean corresponding to the Minnesota prior of Doan, Litterman and Sims (1984) with a
shrinkage parameter of 1.
34
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