Showing posts with label unconventional monetary policy. Show all posts
Showing posts with label unconventional monetary policy. Show all posts

Thursday 11 June 2020

Unconventional Market Policy: Exit Strategy (8)

Special Operations
Overall, special operations other than the traditional repurchase agreements might be needed to sterilise the effects of unconventional policy measures at the appropriate time in the future. 
1.  One option would be to have the fiscal authority issue debt certificates to the market and deposit the proceeds with the central bank. 

  • The switch in the ownership of government debt from the private sector to the monetary authority would alleviate the inflationary pressures arising from the additional liquidity. 

2.  Another option would be for the central bank to issue debt certificates itself, as the ECB for example can do according to its Statute. 

  • In this way the central bank would essentially change the composition of the liabilities side of its balance sheet, moving away from excess reserves and towards less-liquid debt securities. 
  • The effect, compared with government debt issuance, would in essence be the same.

Financial loss for the central bank
An important final element related to the exit strategy, but which should be considered carefully already when deciding to embark on unconventional measures, is that when the central bank sells the assets their value is likely to have declined considerably, given the higher rate of interest. 

This implies a financial loss for the central bank. 

The consequences for the financial – and overall – independence of the central bank should not be downplayed.

Unconventional Market Policy: Exit Strategy (7)

Getting the timing right in withdrawing additional liquidity
Getting the timing right in withdrawing additional liquidity is likely to be decisive in order to ensure a non-inflationary recovery. 
Generally speaking, the lower the reversibility of the non-conventional operations, the larger the risk of being behind the curve when the macroeconomic and financial market situation improves.
Indeed, to a large extent the speed of unwinding of unconventional measures would depend on their degree of reversibility. 
(A)  Some of the unwinding would happen automatically as central bank programmes become increasingly unattractive as financial conditions normalise

  • For instance, many lending facilities provide liquidity at a premium over the main policy rate or with a high haircut applied to the required collateral, making interbank lending the more attractive option once normal lending activity among market participants is restored. 
  • As a result, the central bank’s balance sheet would decline automatically as demand for its funds decreases. 
  • As noted, the ECB’s current liquidity-providing operations imply an ‘endogenous’ exit strategy as banks would automatically seek less credit from the ECB when tensions in financial markets ease. 
  • The speed of the reversibility would therefore largely depend on the speed of the resurgence of the financial system. 
(B)  In the euro area, the revitalisation of money markets is key to the ECB’s exit strategy and any future interest rate decision should therefore avoid a further disruption of money markets. 

  • In this context, bringing the main policy rate too close to zero would risk hampering the functioning of the money markets as it would reduce the incentives for interbank lending. 
  • This, in turn, could blur the important signals coming otherwise from the resurgence of interbank lending and the associated positive effect on the ECB’s balance sheet.
(C)  Obviously, the speed of tightening would also depend on the maturity of the assets bought by central banks within the framework of their easing programmes. 

  • Differences in the maturity of assets will ensure that a tightening of the accommodative stance would come in gradual tranches. 
  • This is important to avoid any abrupt tightening of credit conditions in the middle of the recovery. 
  • At the same time, measures centered on assets that are longer-term in nature and less liquid could pose challenges to the future unwinding of these measures. 
  • If market conditions were to improve faster than expected, an increase in the average maturity of the central bank’s portfolio would make it more difficult for financial markets to return to normal private sector functioning and would also heighten medium-term inflation risks.


Unconventional Monetary Policy: Exit Strategy (6)

How quickly should policy-makers reverse their policies? 
On the one hand, withdrawing liquidity in such large quantities will trigger a substantial contractionary monetary policy shock. 
The large size of many easing programmes will make it difficult to sell assets without a significant market impact. 
If it happens too quickly or abruptly, policy-makers risk choking off the economic recovery or imposing heavy capital losses on lenders. 

  • For instance, in the corporate bond or commercial paper market, even small sales of securities by the central bank could cause spreads to widen considerably and to sharply tighten credit conditions for firms. 
On the other hand, with policy rates at record low levels and additional liquidity-providing measures adopted in so many countries, the possibility of inflation risks emerging sometime later is not something that can be excluded. 

  • Retaining such exceptional policy measures for too long might aggravate the upside risks to price stability and sow the seeds for future imbalances in financial markets.


Unconventional Monetary Policy: Exit Strategy (5)

Reaction of the Financial Markets to the Start of Unwinding

This raises the question of the reaction that financial markets might have to the start of the unwinding of the direct easing measures. 

1.   How would markets react to the central bank starting to sell the government bonds it purchased under the direct quantitative easing policy? 
Such a start would signal presumably that the tightening cycle is close and could affect yields. 

2.  If the amount of assets to be sold is significantthis can have an impact on the market conditions of the underlying assets, possibly further depressing its price.

Unconventional Monetary Policy: Exit Strategy (4)

Unwinding of 'Credit Easing' Policies (Unwinding the Purchase of Corporate Bonds)

Measures taken through the purchase of corporate bonds aim to revitalise the flow of credit in certain market segments.

These measures are primarily designed to bypass the financial sector and to ensure that non-financial corporations still have access to external financing. 
Now, in theory, by stimulating longer-term investments and hence aggregate demand, these measures might induce inflationary pressures in the medium to long-term, independent of the functioning of money markets and lending by banks. 
The strength of this channel depends on the depth of the corporate bond market. 

  • If policy-makers were to react to these inflationary pressures by raising interest rates pre-emptively while money markets were still weak, the consequences for the banking channel of intermediation could be severe. 
  • If, however, markets were to function properly again, there would be no reason to postpone the unwinding of ‘credit easing’ policies to a date longer than needed. 
Taken together, this reasoning suggests that purchases of privately issued securities should be unwound before or at the same time as interest rates are raised back to normal levels.



Unconventional Monetary Policy: Exit Strategy (3)

What are the implications for the sequencing of unwinding conventional and unconventional policy measures? 
It means that non-standard measures that aim mainly at restoring the orderly functioning of money markets, such as supplementary longer-term refinancing operations or an extended menu of eligible collaterals, might have to be rolled back before interest rates are increased again.


Why?
(A)  First of all, because raising interest rates in an environment in which such unconventional measures were still judged to be necessary would risk undermining a sustained recovery by money markets
If concerns about the required and available amounts of short-term funding still prevailed among market participants, raising rates might reinforce these fears and could lead to further, unwarranted upward pressure on overnight rates. 
(B)  Second, supplying extra liquidity to the markets through non-standard measures while, at the same time, tightening monetary policy would send mixed signals on the effective monetary policy stance. 
Measures to alleviate the strains in money markets could in fact be seen as a continued easing of the monetary policy stance. 
(C)  Third, with non-standard measures such as the unlimited provision of liquidity still in place it might be more difficult for the central bank to steer the level of market rates consistent with its policy target
For example, a fixed rate tender with full allotment usually leaves the banking sector with a large daily liquidity surplus, which needs to be mopped up by additional fine-tuning operations towards the end of the reserve maintenance period in order to avoid a sharp drop in the overnight interest rate. 
This, however, causes extra volatility in the markets as well as large interest rate fluctuations that are undesirable from the point of view of an effective signalling of the monetary policy stance. 
(D)  Fourth, with markets still in need of additional non-standard measures, the pass-through of an increase in policy rates would probably be hampered. 
The orderly transmission of any monetary tightening would only resume once trust among market participants has had been restored and money markets were operating normally again. 
(E)  Finally, in any bank-dominated system of fund intermediation, in which the recovery of the economy largely depends on the soundness of the banking system, inflationary pressures that would require a tightening of monetary policy are likely to appear only when the banks take up their normal lending activity again. 
This, in turn, implies that non-standard measures should ideally be rolled back before interest rates were increased.


Unconventional Monetary Policy: Exit Strategy (2)

Most of the unconventional measures (quantitative easing and credit easing) put in place are designed to stimulate lending, to convince savers to hold risky longer-term assets.

The extremely low interest rates and ample liquidity aims at favouring borrowers and penalising lenders over the medium term.

The effectiveness of these measures mainly depends on the readiness of banks to go back to their main business of lending to households and firms rather than parking excess reserves with the central bank.



Problem of Exiting or Reversing
Prospects of rising interest rates may discourage private savers from purchasing longer-term assets, as a tightening of monetary policy inevitably implies a capital loss for those who bought these assets. 

An increase in policy rates – and in particular in the deposit rate – risks undermining banks’ incentive to re-engage in funding the private sector. 

Raising policy rates, or the expectation of such increases, when confidence is not fully restored could therefore be counterproductive.


Unconventional Monetary Policy: Exit Strategy (1)


EXIT STRATEGY

How and when do central banks need to unwind the extra monetary stimulus? 
Simple answers:
  • when the economy rebounds and 
  • inflationary prospects are back in line with the central bank’s price stability objective. 

Not Easy
Unfortunately, for a number of reasons, formulating an adequate exit strategy is not such an easy task. Why? 
Two choices that need to be made: 
  • first, devising the right sequence for the phasing out of the conventional and unconventional monetary policy accommodation; 
  • second, deciding on the speed at which the unconventional accommodation is removed.

To unwind unconventional monetary policy operations (in the case of quantitative easing and credit easing policies)
  • it normally implies selling assets outright, and in significant amounts

In the case of the endogenous easing measures, the unwinding happens automatically, since banks should naturally 
  • reduce their demand for central bank money and 
  • increase interbank lending as their situation normalises.



Reference:


Conventional and unconventional monetary policy
Lorenzo Bini Smaghi,
Member of the Executive Board of the European Central Bank,
Keynote lecture at the International Center for Monetary and Banking Studies (ICMB),
Geneva, 28 April 2009

KEYNOTE LECTURE AT THE INTERNATIONAL CENTER FOR MONETARY AND BANKING STUDIES (ICMB),

GENEVA, 28 APRIL 2009

HOW ARE UNCONVENTIONAL MEASURES IMPLEMENTED?

1 Direct Quantitative Easing

2 Direct Credit Easing

3 Indirect (or Endogenous) Quantitative/Credit Easing


Saturday 6 June 2020

Unconventional Monetary Policy: Conclusion (8)

KEYNOTE LECTURE AT THE INTERNATIONAL CENTER FOR MONETARY AND BANKING STUDIES (ICMB),
GENEVA, 28 APRIL 2009

HOW ARE UNCONVENTIONAL MEASURES IMPLEMENTED?

1 Direct Quantitative Easing

2 Direct Credit Easing

3 Indirect (or Endogenous) Quantitative/Credit Easing



Conclusions

To conclude, the decision whether to embark on non-conventional monetary policy measures, which specific ones and for how long depends on a series of considerations, including

  • the overall conditions of the economy, in particular the presence of deflationary pressures and 
  • the effective constraint provided by the zero lower bound for interest rates, 
  • the structure of the financial flows in the economy, 
  • the medium term incentives that would be created for the private sector and 
  • the risks entailed in the exit strategy, including for the independence and credibility of the central bank. 


Some measures present greater advantages, in terms of providing the right incentives and being easily reversible. 

Others present more risks and have to be well targeted and used under specific circumstances. 

Considering the pros and cons of the various measures requires deep thinking. 

I have tried to develop tonight some of the considerations underlying such a reflection.

Hopefully this has been useful in understanding why the ECB has proceeded speedily in some areas while taking the necessary time to reflect on others.
Thank you very much for your attention.




Conventional and unconventional monetary policy
Lorenzo Bini Smaghi,
Member of the Executive Board of the European Central Bank,
Keynote lecture at the International Center for Monetary and Banking Studies (ICMB),
Geneva, 28 April 2009

Unconventional Monetary Policy: Exit Strategy (7)

KEYNOTE LECTURE AT THE INTERNATIONAL CENTER FOR MONETARY AND BANKING STUDIES (ICMB),
GENEVA, 28 APRIL 2009

HOW ARE UNCONVENTIONAL MEASURES IMPLEMENTED?

1 Direct Quantitative Easing

2 Direct Credit Easing

3 Indirect (or Endogenous) Quantitative/Credit Easing



Exit strategy

Let me now turn to the last of the four questions that I posed earlier on: how and when do central banks need to unwind the extra monetary stimulus? The simple answer to this question would be – of course – when the economy rebounds and inflationary prospects are back in line with the central bank’s price stability objective. Unfortunately, for a number of reasons, formulating an adequate exit strategy is not such an easy task. Why? Let me mention two choices that need to be made: first, devising the right sequence for the phasing out of the conventional and unconventional monetary policy accommodation; second, deciding on the speed at which the unconventional accommodation is removed.
Let me first clarify what it means, in practice, to unwind unconventional monetary policy operations. In the case of quantitative easing and credit easing policies, it normally implies selling assets outright, and in significant amounts. In the case of the endogenous easing measures, the unwinding happens automatically, since banks should naturally reduce their demand for central bank money and increase interbank lending as their situation normalises.
Starting with the problem of the right sequence, it should be reminded that an environment of extremely low interest rates and ample liquidity aims at favouring borrowers and penalising lenders, over the medium term, when the policy is reversed. On the other hand, most of the unconventional measures put in place are designed to stimulate lending, to convince savers to hold risky longer-term assets. The effectiveness of these measures therefore mainly depends on the readiness of banks to go back to their main business of lending to households and firms rather than parking excess reserves with the central bank. Clearly, an increase in policy rates – and in particular in the deposit rate – risks undermining banks’ incentive to re-engage in funding the private sector. In a similar vein, prospects of rising interest rates may discourage private savers from purchasing longer-term assets, as a tightening of monetary policy inevitably implies a capital loss for those who bought these assets. Raising policy rates, or the expectation of such increases, when confidence is not fully restored could therefore be counterproductive.
What, then, are the implications for the sequencing of unwinding conventional and unconventional policy measures? In simple terms, it means that non-standard measures that aim mainly at restoring the orderly functioning of money markets, such as supplementary longer-term refinancing operations or an extended menu of eligible collaterals, might have to be rolled back before interest rates are increased again. Why?
First of all, because raising interest rates in an environment in which such unconventional measures were still judged to be necessary would risk undermining a sustained recovery by money markets. If concerns about the required and available amounts of short-term funding still prevailed among market participants, raising rates might reinforce these fears and could lead to further, unwarranted upward pressure on overnight rates. Second, supplying extra liquidity to the markets through non-standard measures while, at the same time, tightening monetary policy would send mixed signals on the effective monetary policy stance. Measures to alleviate the strains in money markets could in fact be seen as a continued easing of the monetary policy stance. Third, with non-standard measures such as the unlimited provision of liquidity still in place it might be more difficult for the central bank to steer the level of market rates consistent with its policy target. For example, a fixed rate tender with full allotment usually leaves the banking sector with a large daily liquidity surplus, which needs to be mopped up by additional fine-tuning operations towards the end of the reserve maintenance period in order to avoid a sharp drop in the overnight interest rate. This, however, causes extra volatility in the markets as well as large interest rate fluctuations that are undesirable from the point of view of an effective signalling of the monetary policy stance. Fourth, with markets still in need of additional non-standard measures, the pass-through of an increase in policy rates would probably be hampered. The orderly transmission of any monetary tightening would only resume once trust among market participants has had been restored and money markets were operating normally again. Finally, in any bank-dominated system of fund intermediation, in which the recovery of the economy largely depends on the soundness of the banking system, inflationary pressures that would require a tightening of monetary policy are likely to appear only when the banks take up their normal lending activity again. This, in turn, implies that non-standard measures should ideally be rolled back before interest rates were increased.
This reasoning might not hold for measures taken to revitalise the flow of credit in certain market segments – such as through the purchase of corporate bonds. These measures are primarily designed to bypass the financial sector and to ensure that non-financial corporations still have access to external financing. Now, in theory, by stimulating longer-term investments and hence aggregate demand, these measures might induce inflationary pressures in the medium to long-term, independent of the functioning of money markets and lending by banks. The strength of this channel depends on the depth of the corporate bond market. If policy-makers were to react to these inflationary pressures by raising interest rates pre-emptively while money markets were still weak, the consequences for the banking channel of intermediation could be severe – for the reasons I have just given. If, however, markets were to function properly again, there would be no reason to postpone the unwinding of ‘credit easing’ policies to a date longer than needed. Taken together, this reasoning suggests that purchases of privately issued securities should be unwound before or at the same time as interest rates are raised back to normal levels.
This raises the question of the reaction that financial markets might have to the start of the unwinding of the direct easing measures. For instance how would markets react to the central bank starting to sell the government bonds it purchased under the direct quantitative easing policy? Such a start would signal presumably that the tightening cycle is close and could affect yields. Furthermore, if the amount of assets to be sold is significant, this can have an impact on the market conditions of the underlying assets, possibly further depressing its price.
Naturally, the question remains: how quickly should policy-makers reverse their policies? On the one hand, withdrawing liquidity in such large quantities will trigger a substantial contractionary monetary policy shock. The large size of many easing programmes will make it difficult to sell assets without a significant market impact. If it happens too quickly or abruptly, policy-makers risk choking off the economic recovery or imposing heavy capital losses on lenders. For instance, in the corporate bond or commercial paper market, even small sales of securities by the central bank could cause spreads to widen considerably and to sharply tighten credit conditions for firms. On the other hand, with policy rates at record low levels and additional liquidity-providing measures adopted in so many countries, the possibility of inflation risks emerging sometime later is not something that can be excluded. Retaining such exceptional policy measures for too long might aggravate the upside risks to price stability and sow the seeds for future imbalances in financial markets.
Getting the timing right in withdrawing additional liquidity is likely to be decisive in order to ensure a non-inflationary recovery. Generally speaking, the lower the reversibility of the non-conventional operations, the larger the risk of being behind the curve when the macroeconomic and financial market situation improves.
Indeed, to a large extent the speed of unwinding of unconventional measures would depend on their degree of reversibility. As I already noted, some of the unwinding would happen automatically as central bank programmes become increasingly unattractive as financial conditions normalise. For instance, many lending facilities provide liquidity at a premium over the main policy rate or with a high haircut applied to the required collateral, making interbank lending the more attractive option once normal lending activity among market participants is restored. As a result, the central bank’s balance sheet would decline automatically as demand for its funds decreases. As noted, the ECB’s current liquidity-providing operations imply an ‘endogenous’ exit strategy as banks would automatically seek less credit from the ECB when tensions in financial markets ease. The speed of the reversibility would therefore largely depend on the speed of the resurgence of the financial system. In the euro area, the revitalisation of money markets is key to the ECB’s exit strategy and any future interest rate decision should therefore avoid a further disruption of money markets. In this context, bringing the main policy rate too close to zero would risk hampering the functioning of the money markets as it would reduce the incentives for interbank lending. This, in turn, could blur the important signals coming otherwise from the resurgence of interbank lending and the associated positive effect on the ECB’s balance sheet.
Obviously, the speed of tightening would also depend on the maturity of the assets bought by central banks within the framework of their easing programmes. Differences in the maturity of assets will ensure that a tightening of the accommodative stance would come in gradual tranches. This is important to avoid any abrupt tightening of credit conditions in the middle of the recovery. At the same time, measures centered on assets that are longer-term in nature and less liquid could pose challenges to the future unwinding of these measures. If market conditions were to improve faster than expected, an increase in the average maturity of the central bank’s portfolio would make it more difficult for financial markets to return to normal private sector functioning and would also heighten medium-term inflation risks.
Overall, special operations other than the traditional repurchase agreements might be needed to sterilise the effects of unconventional policy measures at the appropriate time in the future. One option would be to have the fiscal authority issue debt certificates to the market and deposit the proceeds with the central bank. The switch in the ownership of government debt from the private sector to the monetary authority would alleviate the inflationary pressures arising from the additional liquidity. Another option would be for the central bank to issue debt certificates itself, as the ECB for example can do according to its Statute. In this way the central bank would essentially change the composition of the liabilities side of its balance sheet, moving away from excess reserves and towards less-liquid debt securities. The effect, compared with government debt issuance, would in essence be the same.
An important final element related to the exit strategy, but which should be considered carefully already when deciding to embark on unconventional measures, is that when the central bank sells the assets their value is likely to have declined considerably, given the higher rate of interest. This implies a financial loss for the central bank. The consequences for the financial – and overall – independence of the central bank should not be downplayed.

Friday 5 June 2020

Unconventional Monetary Policy: Indirect (or Endogenous) Quantitative/Credit Easing (6)

KEYNOTE LECTURE AT THE INTERNATIONAL CENTER FOR MONETARY AND BANKING STUDIES (ICMB),
GENEVA, 28 APRIL 2009

HOW ARE UNCONVENTIONAL MEASURES IMPLEMENTED?

1 Direct Quantitative Easing

2 Direct Credit Easing

3 Indirect (or Endogenous) Quantitative/Credit Easing


3 Indirect (or Endogenous) Quantitative/Credit Easing

The measures described above foresee the direct acquisition by the central bank of the assets, in exchange for central bank money. This implies that the central bank directly holds the assets, until maturity or resale, and thus the risk on its balance sheet. An alternative way is to increase the size of the balance sheet by lending to banks at longer maturities, against collateral which includes assets whose markets are temporarily impaired. This policy affects directly the yield curve over the horizon at which policy operations are conducted or committed to be conducted. For instance, monetary policy operations with maturity of 6 months directly affect the 6 months interbank money market. This is particularly the case if the operations are conducted at a fixed rate, full allotment. The horizon of the yield curve which is affected may be lengthened to the extent that the central bank commits to conduct such type of tenders for a given period of time. For instance, if the central bank commits to conduct 6 months refinancing operations with fixed rate tenders for 2 years, the yield curve over the two and a half year horizon is likely to be influenced.
The increase in the monetary base is determined endogenously by the banking system, based on banks’ preference for liquidity and thus on the state of stress of the banking system. In normal conditions, when financial markets function properly, the size of the central bank balance sheet would be such that the overnight rate would coincide with the short term refinancing rate of the central bank and excess reserves are negligible. Under stress, the size of the central bank balance sheet would increase, on the basis of banks’ increased demand for excess reserves, to the point that the overnight rate would be lower than the short term main refinancing rate.
Another aspect of such a policy relates to the quality of the collateral. By enlarging the pool of the collateral accepted for the refinancing operations with the central bank, the financing conditions by banks to these sectors are facilitated, which should be reflected in the credit spreads that banks charge in particular to the corporate sector. This technique also enables the counterparties of the central bank to choose the collateral to use in their refinancing operations. In times of market stress there will be a natural tendency for banks to use a greater amount of assets of a lower quality. The overall collateral deposited with the central bank will vary endogenously, depending on the state of stress of the financial markets. The eligibility of certain categories of assets for monetary policy operations will facilitate their creation and trade among market participants.
In the euro area, the ECB decided to adopt a ‘fixed-rate full-allotment’ procedure: since October 2008 eligible counterparties in the euro area have had access to unlimited liquidity for periods ranging from one week up to six months at a fixed rate. At the same time, we implicitly eased monetary conditions further by expanding the list of assets eligible as collateral in Eurosystem refinancing operations. The Eurosystem accepts a broad range of assets as collateral in all its credit operations. This feature of the Eurosystem’s collateral framework, together with the fact that access to Eurosystem open market operations is granted to a large pool of counterparties, has been key to supporting the implementation of monetary policy in times of stress. The in-built flexibility of its operational framework allowed the Eurosystem to provide the necessary liquidity to address the impaired functioning of the money market without encountering widespread collateral constraints throughout much of 2008. It was only towards the end of the year that, in the light of the extension of refinancing for terms longer than overnight in euro and in US dollars as well as the recourse to fixed rate full allotment tender procedures, the Governing Council decided to expand the list of eligible collateral on a temporary basis until the end of 2009.
In 2008 the average amount of eligible collateral increased by 17.2%, compared with 2007, to a total of €11.1 trillion. As regards the composition of collateral put forward, the average share of asset-backed securities increased from 16% in 2007 to 28% in 2008, overtaking uncovered bank bonds as the largest class of assets put forward as collateral with the Eurosystem. Uncovered bank bonds accounted on average for slightly less than 28% of the collateral put forward in 2008. The average share of non-marketable assets increased from 10% in 2007 to 12% in 2008. By contrast, the average share of central government bonds dropped from 15% in 2007 to 10% in 2008.
In my opinion, these changes to our monetary policy implementation can be better characterised as ‘endogenous credit easing’ rather than ‘quantitative easing’, since the main aim is to relax banks' collateral and funding liquidity constraints, so that they will expand credit supply. Moreover, it is a policy that has been implemented at above-zero level of the short term nominal interest rates.
It should also be emphasised that, given the importance of the banking channel in providing credit to the economy, the unconventional policy measures that would best suit the euro area are likely to differ in terms of scope and depth from those in the US or other advanced economies where a more market-based financial system prevails, a consideration that is too often overlooked. This is the main reason why our policy response so far has been tailored to the specific nature of Europe’s financial structure. A few figures will give an idea of the differences in the financial systems of the US and the euro area. For example, at the end of 2007, the stock of outstanding bank loans to the private sector amounted to around 145% of GDP in the euro area, but only to 63% in the United States. By contrast, outstanding debt securities – a measure of the depth of financial markets – amounted to 81% of GDP in the euro area as against 168% in the United States.
The ECB operations have eased financing conditions for the private sector and allowed banks to refinance loans more easily than would otherwise have been the case. The evidence on the extent of these policy measures on market interest rates and money market conditions is quite encouraging. While the spread between the three-month Euribor and the EONIA is now at levels well below 100 basis points as well as at comparable levels or below the corresponding spreads seen in the US and the UK, ECB refinancing operations are also down from a peak of €857 billion at the beginning of the year to 676 billion last Friday. There is also mounting evidence that the Eurosystem’s policy measures have been effective in averting a dramatic contraction in credit volumes, though credit developments certainly need a close monitoring in the period ahead.

Unconventional Monetary Policy: Direct Credit Easing (5)

KEYNOTE LECTURE AT THE INTERNATIONAL CENTER FOR MONETARY AND BANKING STUDIES (ICMB),
GENEVA, 28 APRIL 2009


How are unconventional measures implemented?

1 Direct Quantitative Easing

2 Direct Credit Easing

3 Indirect (or Endogenous) Quantitative/Credit Easing




2 Direct Credit Easing

Credit easing is a policy that directly addresses liquidity shortages and spreads in certain (wholesale) market segments through the purchase of commercial paper, corporate bonds and asset-backed securities. The effectiveness of measures which are aimed at wholesale financial markets depends on their importance in the financing of households and firms, which varies considerably from country to country. (It is notably lower in the euro area than in the US, for example). It is also a more attractive strategy in times of acute bank distress, for obvious reasons.
Two things need to be noted here. First, buying privately issued securities is not fundamentally different from buying government bonds in terms of the impact on the money supply or the monetary base. Second, buying privately issued securities implies that the central bank interacts directly with the private sector and is thus stepping into the realm of credit risk – just as any normal commercial bank would do. Outright purchases of privately issued securities affect the risk profile of the central bank’s balance sheet. In order not to compromise the financial independence of the central bank, policy-makers need to carefully assess the eligibility of all assets on account of the implications they could have for the risk exposure of the central bank’s balance sheet.
Caution is also called for in another respect. Outright purchases of privately issued securities need to be carefully planned to avoid allocative distortions in terms of industries, firms or regions. Also the size of the issuer matters. While it is easy to see how large firms can benefit from the central bank’s purchases of privately issued securities, it is more difficult to ensure that small and medium-sized companies get equal treatment. Given the limited depth of corporate bond markets in many economies, purchases of privately issued securities might therefore be a difficult endeavour for policy-makers.
The Federal Reserve’s approach since December 2007 has been a high-profile example of credit easing. The Fed has established several lending programmes to provide liquidity and improve the functioning of key credit markets. The Term Auction Facility, for instance, helps to ensure that financial institutions have adequate access to short-term credit, while the Commercial Paper Funding Facility provides a backstop for the market for high-quality commercial paper.   More recently, the Fed, in cooperation with the US Treasury Department, has begun to purchase asset-backed securities such as mortgage securities backed by government-sponsored enterprises (GSEs).
How effective have these measures been? It’s too early to say. Moreover, with a wide range of unconventional monetary policy measures – since March the Fed has also been purchasing government bonds in parallel – it is extremely difficult to single out the impact of any specific measure. That being said, the spreads on eligible commercial paper in the United States have come down following the introduction of the Fed’s Commercial Paper Funding Facility (see Chart 1). Also, the Fed’s purchases of GSE debt and GSE-guaranteed mortgage-backed securities have resulted in a decline of the 30-year conforming mortgage rates by more than one percentage point following the announcement of this programme in late November 2008, and have continued to decline since its expansion on 18 March 2009 (see Chart 2). The narrowing of the spread between mortgage rates and Treasuries also suggests that the Fed’s programme of purchasing agency-related mortgage securities may have been effective in easing mortgage market conditions.