85th International Atlantic Economic Conference

March 14 - 17, 2018 | London, United Kingdom

The Glass-Steagall act and U.S. monetary policy

Friday, 16 March 2018: 3:20 PM
Chulho Jung, Ph.D , Economics, Ohio University, Athens, OH
Jay E. Ryu, Ph.D. , Ohio University, Athens, OH
Many recent empirical studies have reported interesting findings on how monetary policy interventions affect gross domestic product (GDP) in the U.S. The studies from the Bureau of Economic Analysis, which used sample periods between the 1980s and the late 2000s, found that contractionary monetary policy interventions ironically boosted GDP. The results were almost the same whether they employed the forward looking (or forward guiding) shock measures or the conventional backward looking shock measures with federal funds rate identification. The results from these studies starkly contrast with the findings from other studies that employed similar shock measures but used different sample periods approximately between the early 1960s and 2000. The latter findings consistently reported that contractionary monetary policy interventions decreased GDP, compatible with standard macroeconomic theory. In this paper, we select a more specific cutoff year for our sample period, which is 1999. We assert that the 1999 repeal of the Glass-Steagall Act via the Financial Services Modernization Act, obtained from the Board of Governors of the Federal Reserve System might have modified the economic motives and behaviors of financial institutions. The 1999 repeal of the Glass-Steagall Act allowed commercial depository banks to do investment-banking business, for instance, purchasing mortgage-backed securities. To the best of our knowledge, however, it seems that no studies have yet investigated how the 1999 repeal might have changed the impact of U.S. monetary policy on business investment and GDP. Our estimation results based on a structural vector autoregressive (SVAR) model show that U.S. monetary policy has become less effective since the 1999 repeal of the Glass-Steagall Act. We argue that after the 1999 repeal, increased credits through U.S. monetary policy mostly flowed into the financial sector to increase the profits of the U.S. financial institutions instead of stimulating the real sector of the economy through business investment.