That’s the title of a fascinating new paper with important policy implications.
This paper evaluates the popular view that quantitative easing exerts greater international spillovers than conventional monetary policies. We employ a novel approach to compare the international spillovers of conventional and balance sheet policies undertaken by the Federal Reserve. In principle, conventional
monetary policy affects bond yields and financial conditions by affecting the expected path of short rates, while balance-sheet policy is believed act through the term premium. To distinguish the effects of these two types of policies we use a term structure model to decompose longer-term bond yields into expected short-term interest rates and term premiums. We then examine the relative effects of changes in these two components of yields on changes in exchange rates and foreign bond yields. We find that the dollar is more sensitive to expected short-term interest rates than to term premia; moreover, the rise in the sensitivity of the dollar to monetary policy announcements since the GFC owes more to an increased sensitivity of the dollar to expected interest rates than to term premiums. We also find that changes in short rates and term premiums have similar effects on foreign yields. All told, our findings contradict the popular view that quantitative easing exerts greater international spillovers than conventional monetary policies.
Ever since Brainard’s speech in 2017 (highlighted in this discussion by Brad Setser), I’ve been wondering how to differentiate between short term interest rate and term premium effects on exchange rates. In this paper, the authors obtain the following estimates.
In one sense, this makes sense, since the term premium is a liquidity/inflation risk term, which does not necessarily map to the exchange risk premium which might depend on very different things that determine the term premium. Short term interest rates on the other hand are phenomena most directly linked to the first moments of monetary policy, which should matter the most for nominal exchange rates. But that’s conjecture on my part…