The Transmission Mechanism of Quantitative Easing : A Markov-Switching FAVAR Approach

This article assesses the impact of unconventional monetary policies and sheds light on their transmission mechanism in the United States. Using a three-variable Markov switching factor-augmented vector autoregression (MS-FAVAR) with time-varying transition probabilities and a shadow short-term interest rate, we allow our analysis to be free from arbitrary policy rate decisions and sample-splitting choices. By augmenting our informational set with variables able to grasp the functioning of Quantitative Easing, we can determine the differences between conventional and unconventional expansionary monetary policy shocks. Our results show a leading role for both the duration risk and the credit channels, a role for the default risk channel, and ultimately no evidence of the presence of a signaling channel during Quantitative Easing. We provide evidence that the large-scale asset purchase programs of the Federal Reserve effectively boosted the economy, mainly by modifying the term structure of the interest rates, thus providing strong economic stimulus throughout the financial sector