Conventional Monetary Policy and the Term Structure of Interest Rates during the Financial Crisis

This paper analyzes whether the Fed had the ability through its conventional monetary policy to affect key economic and financial variables, and, in particular, the term structure of interest rates, during the recent financial crisis. This departs from the empirical literature that focuses mainly on the effectiveness of unconventional monetary policies during this episode, although these policies are appropriate only to the extent that the conventional policy was ineffective in the first place. Our identification strategy based on the conditional heteroskedasticity of the structural innovations allows us to specify a flexible structural vector auto-regressive process that relaxes the identifying assumptions commonly used in earlier studies. Comparing our results obtained from samples excluding and including the financial crisis, we find that the conventional monetary policy has lost its effectiveness shortly after the beginning of the financial turmoil. This result suggests that the Fed's use of unconventional policies was appropriate, at least, with the objective of changing the term structure of interest rates.