In the wake of the global financial crisis in 2008, nominal interest rates in the US and other advanced economies have approached the effective lower bound (ELB). This fact has motivated new research to understand, both theoretically and empirically, the impact of monetary policies when the nominal policy rate is at the ELB. In a new paper, we show that accounting for balance sheet policies (QE) can ease the constraints imposed by the ELB on monetary policy and resolve several paradoxical results arising in canonical New Keynesian models at the ELB. The ‘paradox of flexibility’, the ‘paradox of toil’ and the puzzle of excessively large fiscal multipliers are all resolved when QE is added to the model as policy tool.
During 2020 the MPC announced a further £450 billion of QE purchases, slightly more than the total amount of assets purchased over the preceding ten years, taking the target QE stock to £875 billion of gilt holdings and £20 billion of sterling investment-grade corporate bonds. We study the high-frequency reaction of gilt markets to these QE announcements in light of the surprises to market expectations of the future QE path. We find the yield reactions to be broadly consistent with news about the expected medium-term stock of QE. This is in line with recent commentary, which has focused on the ‘pace of purchases’, as a faster/slower pace translated into a larger/lower stock of expected purchases, and could capture the effects of the local supply channel. The reaction to news about purchase pace could also be potentially consistent with an impact on expected liquidity premia or expected policy rates.
Ben Bernanke famously remarked that “the trouble with QE is that it works in practice but not in theory”. And ahead of its adoption, many academics were sceptical that QE would have any effects at all. Yet despite QE being a part of the monetary policy landscape for nearly a decade, the bulk of academic research on QE has been on its empirical effect, with relatively little on theory and less still on normative policy questions. In a recent Staff Working Paper I develop a model which can provide answers to questions such as: “How should monetary policymakers return their instruments to more normal levels?” and “Should QE be part of the regular monetary policy toolkit?”
Since QE began, banks have had a lot more liquidity to make payments. But some have argued (in a nutshell) that banks are reliant on this extra liquidity to make their CHAPS payments and it would be difficult to remove it from the system. Our analysis shows that banks don’t need a great deal of liquidity to make their payments simply because they recycle such a high proportion of them. In practical terms, banks do not rely on high reserves balances to make their CHAPS payments so unwinding QE shouldn’t have any impact on banks’ ability to do just that. We also briefly go over the potential reasons for this such as the CHAPS throughput rules, the Liquidity Savings Mechanism, and the tiered structure of CHAPS.
When the ECB announced an extension of its asset purchase programme on December 3 2015, the euro appreciated, bond yields rose and equity prices fell. This does not mean that the extension tightened monetary policy, but merely that it was smaller than what markets had priced in. In order to calculate the full impact of the programme on asset prices, we need to measure both the anticipation effect and announcement effect and add the two up. Our analysis suggests that the announcement effect undid about half of the anticipation effect, and so the extension of asset purchases still pushed down yields, supported equity valuations and depreciated the euro. However, compared to the initial programme, its impact on asset prices was smaller. Continue reading “Too eagerly anticipated: The impact of the extension of ECB QE on asset prices”→
When Friedman famously conjured up images of banknotes fluttering from helicopters in 1969, perhaps he knew he was about to inspire decades of sky-bound puns and policies in the name of deflation avoidance. Helicopter money goes beyond standard fiscal and monetary policy by boosting economic activity using money created by the central bank – money that does not have to be paid back. To its modern advocates, the tale is one of blue-sky thinking that could avert the next recession. But is this just pie in the sky? This post discusses why such a policy is different to quantitative easing, why it is unlikely to have much impact relative to conventional fiscal measures and the pitfalls associated with pursuing it. Continue reading “Helicopter money: setting the tale straight”→