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Explaining the Fed’s recent conventional and unconventional monetary policy

This FRED graph chronicles the advent of “unconventional” monetary policy in the US since the 2007-08 financial crisis and the recent efforts by the Federal Reserve to normalize monetary policy. The graph shows the unemployment rate (in blue), the stock of mortgage-backed securities held by the Federal Reserve (in green), and the effective federal funds rate (in red). While the first series reflects an objective of monetary policy, the other two series reflect instruments of monetary policy: the federal funds rate being a “conventional” instrument and the large holdings of mortgage-backed securities being an “unconventional” instrument.

Three recessions are visible, represented by gray shaded areas. In each recession, the unemployment rate increased and, in response, the Federal Reserve lowered the federal funds rate to stimulate economic activity. After the 2007-08 financial crisis, the federal funds rate became so low (virtually zero) that there was no way to lower it any further. So, the Fed put in place alternative means of stimulating the economy—hence, the label “unconventional monetary policy,” which includes large purchases of mortgage-backed securities starting in late 2008 (again: the green line). These unconventional actions by the Federal Reserve are often referred to as quantitative easing (QE). By purchasing large quantities of assets, the Federal Reserve lowered their yields, which is a mechanism akin to lowering interest rates to stimulate economic activity.

As the unemployment rate declined from its 2010 peak, the Federal Reserve started, in 2016, to “normalize” its monetary policy first by raising the federal funds rate again and then, in 2018, by gradually reducing the stock of mortgage-backed securities it held.

In 2020, the COVID-19-induced crisis prompted the Federal Reserve to lower the federal funds rate to its lowest possible level once again and to further stock up on mortgage-backed securities.

The unemployment rate declined rapidly after 2020 and, in 2022, the Federal Reserve started to raise the federal funds rate and reduce its holdings of mortgage-backed securities again. In this instance, however, inflation (not represented on the graph) played an important role. Until 2021, inflation had changed little, particularly in comparison with the changes in the unemployment rate. With the rise of inflation in 2021, the Federal Reserve had an additional motivation to increase the federal funds rate.

How this graph was created: An “Unemployment Rate” link will likely be under the “Trending Search Terms” heading, which is below the search bar on FRED’s homepage. Click that link and then click the “Unemployment Rate” series link at the top of the results list. Click on “Edit Graph” and then “Add Line.” Use the series code EFFR in the search box and then “Add data series.” Click on “Edit Graph” and “Add Line” again and use the series code WSHOMCB in the search box and then “Add data series.” Click on “Edit Graph” yet again and use the “Format” tab to select “right” as “Y-axis position” for Line 3. Enter 2000-01-01 as the start date above the graph.

Suggested by Guillaume Vandenbroucke.

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