Andrés, López-Salido and Nelson (2004) incorporate imperfect substitutability between short- and long-term bonds. Here the lack of a secondary market for long bonds is the source of the friction. In this model, base money expansion by a central bank can relieve portfolio constraints and lead to an increase in demand for long bonds, thereby raising their prices. Much of this literature is still in its infancy and there is some way to go before it can be combined within an applied, quantitative model that policy makers can use. But the central message I take from this work is that there are a number of channels through which monetary policy is likely to be able to influence the economy at the zero bound. Unfortunately, the financial crisis meant that we had to put these insights into practice. When doing so at the Bank, we placed weight on three key channels of monetary transmission: the impact of imperfect substitutability and the portfolio rebalancing channel on relative prices, the role of financial market liquidity, and the importance of expectations. All three channels were important in the design of the Committee’s asset purchase programme. Let me take them in turn. Channels of transmission To date, the Bank has purchased £ billion of assets financed by the issuance of central bank reserves, the vast majority of which have been relatively long maturity gilts. The central objective underlying those gilts purchases was to inject a substantial amount of additional money into the economy.
One year on from reaching the effective lower bound of interest rates and starting a policy of quantitative easing, there is still much for academics and policy makers to learn. I hope today’s conference will mark another step in that collaboration. References Andres, J, Lopez-Salido, D J and Nelson, E (2004), “Tobin’s imperfect substitution in optimising general equilibrium”, Journal of Money, Credit and Banking, Vol. 36, No. 5, pages 665–90. Bernanke, B S, Reinhart, V R and Sack, B P (2004), “Monetary policy alternatives at the zero bound: an empirical assessment”, Brookings Papers on Economic Activity, Issue 2, pages 1–78. Brunnermeier, M K and Pedersen, L H (2009), “Market liquidity and funding liquidity”, Review of Financial Studies, Vol. 22(6), pages 2201–38. BIS Review 29/2010  7  Duffie, D, Gârleanu, N and Pedersen, L H (2007), “Valuation in over-the-counter markets”, The Review of Financial Studies, Vol. 20. Del Negro, M, Eggertsson, G, Ferrero, A and Kiyotaki, N (2009), “The great escape? A quantitative evaluation of the Fed’s non-standard policies”, Manuscript, Federal Reserve Bank of New York and Princeton University. Eggertsson, G and Woodford, M (2003), “The zero bound on interest rates and optimal monetary policy”, Brookings Papers on Economic Activity 1, 212–219. Fisher, P (2010), “The corporate sector and the Bank of England’s Asset Purchases”, Association of Corporate Treasurers Winter Paper. Gertler, M and Kiyotaki, N (2009), “Financial intermediation and credit policy in business cycle analysis”. Manuscript, New York University and Princeton University.