The effectiveness of the federal funds rate as the U.S. monetary policy tool before, during and after the great recession

Abstract

The effectiveness of the Federal Reserve’s policy of quantitative easing via large-scale asset purchase programs has been studied extensively. This paper distinguishes itself by examining the effectiveness of the federal funds rate as the U.S. monetary policy tool before, during and after the Great Recession of 2007-09. The zero lower bound came into play one year into the Great Recession, having dropped 425 basis points from the cycle peak. We begin by evaluating using the Wald test for Granger causality and the Johansen test for cointegration presence whether or not the changes in the federal funds rate affected the term structure of Treasury securities. Given that equity markets are sensitive to changes in interest rates, we next examine the impact of the federal funds rate changes on the level and volatility of the U.S. stock market. Our analysis reveals that the Fed policy of lowering the federal funds rate during the Great Recession was effective, resulting in changes in the Treasury term structure during but not after the Great Recession. Additionally, the Fed’s policy actions influenced the stock market and its volatility during the Great Recession only.