Ben Bernanke
has a very interesting review paper on QE.
Here are some excerpts.
1.
He focusses on large-scale asset purchases when the
Central Bank (CB) has got to the effective lower bound.
2.
The Fed focus was “former emphasized the effects
of buying longer-term assets on longer-term interest rates”
3.
To know if QE will work we have to know what
determines long term yields. “Longer-term
yields can be conceptually divided into (1) the average expected short rate
over the life of the security, and (2) the difference between the total yield
and the average expected short rate, known as the term premium.”
4.
He then splits the effects into two
a.
“To a first approximation, portfolio balance
effects work by affecting the term premium, while the signaling effect works by
influencing expectations of future short rates.”
5.
These effects are:
a.
“portfolio balance effect. if investors have “preferred habitats”
because of specialized expertise, transaction costs, regulations, liquidity
preference, or other factors, then changing the net supplies of different
securities or classes of securities should 6 affect their relative prices.
b.
signaling effect. if QE serves as a commitment mechanism, or
perhaps as a signal of seriousness, leading investors to believe that
policymakers intend to keep short-term policy rates low for an extended period….market
participants are typically confident that central banks will not raise
shortterm interest rates so long as asset purchases are continuing. Since QE
announcements typically include information about the likely duration of
purchases, which may be measured in quarters or years, and since QE programs
are rarely terminated prematurely (because of the likely costs to policymakers’
credibility), the initiation or extension of a QE program often pushes out the
expected date of the first short-term rate increase. Observing this signal that
short rates will be kept low, investors bid down longer-term rates as well.”
6.
He then goes onto the evidence.
a.
The early data were on event studies and
appeared to show important effects. “Evidently, QE1 had powerful announcement
effects, including a full percentage point decline in the yield on 10-year
Treasuries and more than a percentage point decline in the yields on
mortgage-backed securities. Qualitatively, these results hold up well for
different choices of event days or for shorter or longer event windows.”
Table 1. Responses of asset prices and yields to QE1 announcements
2-year Treasuries -57
10-year Treasuries -100
30-year Treasuries -58
Mortgage-backed securities -129
AAA corporate bonds -89
SP500 index 2.32
b.
But is this evidence clear? He continues
i.
“First, in contrast to the results shown in
Table 1 for QE1, event studies of later rounds of quantitative easing have
tended to find much less dramatic effects. …. A possible interpretation is that
the initial rounds of QE were particularly effective because they were
introduced… in a period of exceptional dysfunction in financial markets.
ii.
“second point raised by critics is that event studies,
by their nature, capture asset market reactions over only a short period. ... A
variant of this objection, which takes a slightly longer-term perspective,
begins by pointing out that longer-term Treasury yields did not consistently
decline during periods in which asset purchases were being carried out. For
example, the 10-year yield at the termination of QE1 purchases was actually
higher than it was before QE1 was announced…Using time series methods, Wright
(2011) argues that the effects of post-crisis policy announcements died off
fairly quickly.”
c.
However, he believes these criticisms are
overblown.
i.
“If later QE rounds were largely anticipated,
then their effects would have been incorporated into asset prices in advance of
formal announcements, accounting for the event-study results (Gagnon, 2018).”
ii.
“the prices of assets not subject to Fed
purchases—including corporate bonds, equities, 13 the dollar, and a variety of
foreign assets—moved substantially following announcements of asset purchase
programs…QE also appeared to stimulate the global issuance of corporate bonds...
The cross-asset impacts seem inconsistent with the view that the event-study
findings reflect only asset-specific liquidity effects.” (longer-term yields
did not reliably decline…in part, this pattern can be explained by the
confounding influences on yields of other factors, including fiscal policy, global
etc.)
d.
This relates to stocks and flows “The portfolio
balance channel of QE, recall, holds that policymakers can affect longer-term
yields by changing the relative supplies…a stock view of QE…The alternative
flow view holds that the current pace of purchases is the critical determinant
of asset prices and yields…The flow view would be correct if QE affected asset
prices and yields primarily through short-run liquidity effects”.
He then talks about other policies
1.
forward guidance. “.
a.
Forward guidance takes many forms (such as the
specification of policy targets, economic and policy projections) and occurs in
many venues (speeches and testimonies, monetary policy reports).”
b.
“Delphic guidance is intended only to be
informative, to help the public and market participants understand
policymakers’ economic outlook and policy plans. In contrast, Odyssean guidance….
incorporating a promise or commitment …to conduct policy in a specified,
possibly state-contingent way in the future “.
c.
He remarks that guidance has worked, but is hard
to disentanglbe from QE.
2.
Other New Monetary Policy Tools. Various forms
a.
central banks also purchased a range of private
assets, including corporate debt, commercial paper, covered bonds. These have greater effect on private yields, (but
there are general equilbirm effects )credit risk and political controversy.
b.
“subsidized bank lending through cheap long-term
funding”. “these lending programs were
aimed at broader economic stabilization… offering bank-dependent borrowers the
same access to credit as borrowers with access to securities markets... Most …evidence
on these programs suggests that they lowered bank funding costs, promoted
lending, and improved monetary policy passthrough…However, the efficacy of
these programs seems likely to depend in a complicated way on the health of the
banking system: If banks are well-capitalized, then their need for cheap
liquidity from the central bank may be limited. Conversely, if banks are short
of capital, their lending may be constrained or their incentives to make good
loans distorted, notwithstanding the availability of low-cost funding”.
c.
Negative rates.
He says they might cause switching into cash and affect Bank’s profits,
but aginst that help overall economic conditions.
d.
Yield curve control. He believes this works in
Japan, but might not in the US. “…if long-term yields were pegged, and market
participants came to believe that the future path of policy rates was likely
higher than the targeted yield, the Fed might need to buy a large share of the
outstanding bonds to try to enforce the peg. Those purchases in turn would
flood the banking system with reserves and expose the central bank to large
capital losses. However, pegging
Treasury yields at a shorter horizon, say two years, would likely be feasible”.
3.
What are the costs of risks of these various
tools? He believes all, bar the last, on
financial instability, are small
a.
“Impairment of market functioning….Asset
purchases likely improved market functioning “
b.
“High inflation. … Fed policymakers and staff
understood that, with short-term interest rates near zero, the demand for bank
reserves would be highly elastic and the velocity of base money could be
expected to fall sharply [i.e. that
money and bonds would be near perfect substitutes]…. However, some FOMC
participants did express concern about the possibility that [QE] could
un-anchor inflationary expectations”
c.
Managing exit
d.
Distribution “the research literature is close
to unanimous in its finding that the distributional effects of expansionary
monetary policies… may even work in a progressive direction, for example by
promoting a “hot” labor market”.
e.
Capital losses “The large, unhedged holdings of
longer-term securities associated with asset purchase programs risked
substantial capital losses if interest rates had risen unexpectedly, losses
which in turn could have ultimately reduced the Federal Reserve’s remittances
of profits to the Treasury”.
Finally he discusses “. Financial instability….including but
not limited to the creation of asset bubbles; incentivizing “reach for yield”
and excessive risk-taking by investors; the promotion of excessive leverage or
maturity transformation; and the destabilization of the business models of
insurance companies and pension funds, which rely on receiving adequate
long-run returns, and of banks, whose profits depend in part on their ability
to earn positive net interest margins. U.S. central bankers also heard
frequently from their foreign counterparts, especially in emerging markets,
about the “spillover effects” of Fed policies on financial conditions abroad
(Rey, 2013).” He makes a number of points.
i.
“Increased risk-taking is by no means always a
bad thing, of course: Encouraging banks, borrowers, and investors to take
reasonable risks, rather than hoarding cash and hunkering down, is a desirable
goal for policies aimed at ending a recession or crisis and restoring normal
growth. However, risk-taking may become excessive…”
ii.
“Most participants in that debate agree that
that the first line of defense against financial instability risks should be
targeted regulatory and macroprudential policies..”
iii.
“…the portfolio balance effect of QE involves
pushing some investors out of longer-term Treasuries into other, possibly
riskier assets; but in general equilibrium, by removing duration risk from the
system, QE reduces the riskiness of private-sector portfolios in aggregate,
increases the supply of safe and liquid assets, and helps compensate for
reduced private risk-bearing capacity during periods of high uncertainty”.
