On the effectiveness of the European Central Bank's conventional and unconventional policies under uncertainty

TL;DR

This paper analyzes how the European Central Bank's conventional and unconventional monetary policies perform under different levels of economic uncertainty, revealing that quantitative easing remains effective when uncertainty is high.

Contribution

It introduces a Bayesian ST-VAR model to assess the impact of ECB policies under uncertainty, highlighting the differential effectiveness of policy tools.

Findings

Quantitative easing remains effective during high uncertainty periods.

Conventional policy and forward guidance are less effective when uncertainty is elevated.

Transmission channels are impaired under high uncertainty.

Abstract

In this paper, we investigate the effectiveness of conventional and unconventional monetary policy measures by the European Central Bank (ECB) conditional on the prevailing level of uncertainty. To obtain exogenous variation in central bank policy, we rely on high-frequency surprises in financial market data for the euro area (EA) around policy announcement dates. We trace the dynamic effects of shocks to the short-term policy rate, forward guidance and quantitative easing on several key macroeconomic and financial quantities alongside survey-based measures of expectations. For this purpose, we propose a Bayesian smooth-transition vector autoregression (ST-VAR). Our results suggest that transmission channels are impaired when uncertainty is elevated. While conventional monetary policy is less effective during such periods, and sometimes also forward guidance, quantitative easing measures seem to work comparatively well in uncertain times.