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Enhancing Monetary Policy Tools at Zero Lower Bound: A Novel Approach by Hamilton & Wu

This paper explores the effectiveness of alternative monetary policy tools in a zero lower bound environment through a theoretical model and empirical analysis, focusing on maturity swaps and debt structures. The study provides insights on interest rate impacts and investor behavior. The authors offer contributions to theory improvement and highlight the importance of understanding debt maturity composition.

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Enhancing Monetary Policy Tools at Zero Lower Bound: A Novel Approach by Hamilton & Wu

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  1. The effectiveness of alternative monetary policy tools in a zero lowerboundenvironment James D. Hamiton, Jing C. Wu Discussed by Caterina Rho

  2. Outline of the paper • Theoretical model about the effects of the maturitystructure of publiclyhelddebt on the termstructure of interestrates. • Empiricalanalysis of the effect of a maturity swap operation by the Fed, in normaltimes and at the ZLB. • In normaltimes: decrease of 14 bp in long runinterest rate and increase of 11 bp in short runinterest rate. • At the ZLB: decreaseof 13bp in long terminterestrateswithout an increase in short termrates. • A swap on maturitieshas the sameeffectas an expansive open market operationbased on buying long termdebt.

  3. Mainpoints • Theoreticalapproach: Affine TermStructure model with preferred-habitat investing and market arbitrage. • Empiricalapproach: AR(1) to model pricingfactors, maximum likelihoodestimation. • Mainfinding: historicalmeasures of how the maturitystructure of debtmightaffectthe pricing of level, slope and curvature term-structurerisk.

  4. Contributions of the paper • Improvement in theory: the model is a discrete time version of Vayanos and Vila (2009). • Endogeneitybetween bond supplies and interestrates: minimized by lookingatforecastingratherthancontemporaneousregressions. • Non standard point of view on the role of maturitycomposition of governmentdebt and investorsbehaviour. • Extension with riskyassets.

  5. Comments and suggestions (1) • The analysis in the ZLB frameworkisbased on the assumptionthat agents expect to eventually break out from the ZLB. • Whathappenif the agents expectto remain in the ZLB? E.g. Japan

  6. Source: FRED, St. Louis Fed

  7. Comments and suggestions (2) • Importance of the frequency of data: Modigliani and Sutch(1966) vs Swanson (2011) • In the model the lendershavea preferred habitat, the borrowers are arbitrageurs. • Whatifalso the primary private borrowershave a preferred habitat?

  8. Comments and suggestions (3) • Opening the economy introducingdifferentcountries. • The extension of the paperregardsriskyassetsas non-treasurysecurities. Wecould use treasury bonds issued by differentcountries with differentsovereignriskinstead of private securities.

  9. Conclusion • The paper presents both theoretical and empirical contributions: • Discrete version of a ATS model with preferred-habitat investing and market arbitrage. • Description of the dynamic behavior of the term structure at ZLB. • Role of expectations and preferences. • Additional alternative specifications: open economy setting and “flight to quality”.

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