Research Highlights

Monetary Policy in the Next Recession?

Kim Schoenholtz
By Stephen G. Cecchetti, Michael Feroli, Anil K Kashyap, Catherine L. Mann, and Kim Schoenholtz
When confronted with the next recession, how should central banks support the economy? Because interest rates already are very low in the advanced economies, a further reduction likely will be insufficient to speed recovery. New co-authored research by Professor Kim Schoenholtz examines whether the range of new monetary policy (NMP) tools that were developed over the past decade can do the job.

In “Monetary Policy in the Next Recession?”, which was presented at the annual U.S. Monetary Policy Forum on February 21, 2020, Professor Schoenholtz along with four co-authors conclude that central bankers should incorporate the new tools—including quantitative easing, forward guidance and negative interest rates—into their policy strategies and clearly communicate these plans, but they should be humble about their likely success.

Key findings from the research include:
  • Compared to recessions over the past 60 years, low long-term interest rates already limit the potential for monetary policy tools to ease financial conditions.
  • Much research finds that NMP tools support economic activity at the lower bound for nominal interest rates. Over the past decade, however, they generally were not sufficient to ease financial conditions amid the headwinds that advanced economies faced.
  • This mixed record justifies more activist policy: central banks should be prepared to deploy NMP tools early in a downturn—when it is still feasible to stabilize prices and economic activity—and to do so aggressively.
  • Policymakers should clearly communicate plans for how they will use NMP tools when faced with the next recession, encouraging market participants to anticipate and speed supportive changes in financial conditions.
“It is even possible that more aggressive action would shorten the period of implementation of NMP tools, helping to limit financial stability risks,” the authors write.

The authors note their analysis also raises questions for future exploration, including which tools should be deployed first and whether simultaneously deploying multiple tools would be most effective.

They conclude: “Perhaps the biggest takeaway from our analysis is that in the next recession, monetary policymakers should be humble about how much can be expected from NMP tools.”

Read more about the research in this “Money, Banking, and Financial Markets” blog post.