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.