Measuring the Effectiveness of US Monetary Policy during the COVID-19 Recession

TL;DR

This paper introduces a novel mixed frequency VAR model to evaluate the US Federal Reserve's monetary policy effectiveness during the COVID-19 recession, demonstrating positive impacts on output, markets, and financing conditions.

Contribution

It develops a new high-frequency macro-financial model combining weekly and monthly data to assess policy effects during crises.

Findings

Monetary expansion increased output growth

Stock market returns improved due to policy

Long-term financing conditions became more favorable

Abstract

The COVID-19 recession that started in March 2020 led to an unprecedented decline in economic activity across the globe. To fight this recession, policy makers in central banks engaged in expansionary monetary policy. This paper asks whether the measures adopted by the US Federal Reserve (Fed) have been effective in boosting real activity and calming financial markets. To measure these effects at high frequencies, we propose a novel mixed frequency vector autoregressive (MF-VAR) model. This model allows us to combine weekly and monthly information within an unified framework. Our model combines a set of macroeconomic aggregates such as industrial production, unemployment rates and inflation with high frequency information from financial markets such as stock prices, interest rate spreads and weekly information on the Feds balance sheet size. The latter set of high frequency time series is used to dynamically interpolate the monthly time series to obtain weekly macroeconomic measures. We use this setup to simulate counterfactuals in absence of monetary stimulus. The results show that the monetary expansion caused higher output growth and stock market returns, more favorable long-term financing conditions and a depreciation of the US dollar compared to a no-policy benchmark scenario.