Then comes monetary policy; policy makers are therefore assumed to be able to react to movements in the real economy and in credit markets within the quarter, which does not seem unreasonable. House prices come last. For the United States, the variables in the vector auto-regression are: CPI inflation; GDP growth; the effective Federal Funds rate; the difference between the Merrill Lynch corporate BAA and 10-year Treasury yields; the growth in total private credit market debt outstanding deflated by CPI; the rate of change of house prices (the National Association of Realtors existing homes price index to 1975 linked to the Federal Housing Finance Agency thereafter) deflated by CPI; and the macroeconomic volatility index. For the United Kingdom, the equivalent variables are: CPI inflation; GDP growth; Bank Rate; the difference between the investment-grade corporate bond and 10-year government bond yields; the growth in M4 lending (excluding securitisations and loans to intermediate OFCs) deflated by CPI; the rate of change of house prices (the Nationwide house price index to 1983 linked to the Halifax measure thereafter) deflated by CPI; and the macroeconomic volatility index. The data are quarterly, there are two lags of each variable, and the sample runs from 1966 Q3 to 2010 Q1. A good case can be made for employing only more recent data, on the grounds that monetary policy reaction functions have evolved during this time. But the cost of that is reduced precision and estimates over just the latter part of the period turn out to be rather less well defined.
Indeed in subsequent work (Cúrdia and Woodford, 2010), Woodford himself explores some of the ways that asset purchases might have traction, while Andrés, LópezSalido and Nelson (2004) provide a particular model that embeds imperfect substitutability arising from limited participation within a DSGE framework. Both the Federal Reserve and the Bank of England have bought longer-dated government and private assets, though with different emphases. 6 The Federal Reserve has purchased $ trillion (10 per cent of GDP) worth of Government Sponsored Enterprise debt and mortgage-backed securities guaranteed by them. In addition, the Federal Reserve has purchased $ billion (2 per cent of GDP) worth of US Treasuries. The Bank of England has bought nearly £ billion (14 per cent of GDP) of UK government bonds, together with a small quantity of corporate bonds. The Bank of Japan has also bought around ¥ trillion (3 per cent of GDP) of Japanese government bonds since the crisis deepened in late 2008; that is to be compared with ¥ trillion of purchases during their 2001–6 quantitative easing period. It is worth stressing that neither the Federal Reserve nor the Bank of England has assigned a key role to the expansion of central bank liabilities in the transmission mechanism associated with these asset purchases. In current circumstances, it is plausible to believe that commercial banks would be willing to hold the extra claims on the central bank as liquid assets at, or near, the existing vector of interest rates, rather than lending them on and driving down loan rates.