Unconventional Monetary Policy in Advanced Economies

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Unconventional Monetary Policy in Advanced
Economies

• Vladimir Klyuev
• Research Department
• International Monetary Fund

The views expressed herein are those of the
author and should not be attributed to the IMF,
its Executive Board, or its management.
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Outline

• Reasons for unconventional policies
• Unconventional approaches
• Effectiveness of unconventional policies
• Exit

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Reasons to go unconventional

• Large shock to aggregate demand
• Strains in financial markets
• Elevated spreads
• Disrupted transmission mechanism
• Frozen credit markets
• Zero interest-rate floor

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Central Bank Assets and Policy Rates
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Options for unconventional policy

• Commit explicitly to keeping policy rates low
• Provide broad liquidity to financial institutions
• Purchase long-term Treasury securities
• Intervene directly in impaired credit markets

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Commitment to low policy rates

• Aims at anchoring market expectations that
  monetary stimulus will not be withdrawn until
  durable recovery is in sight
• Easy to announce useful when policy uncertainty
  is high
• Effectiveness hinges on credibility commitment
  has value only to the extent that it restricts
  future options
• So far United States and Canada

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Provision of liquidity

• Frictions in term money markets may necessitate
  going beyond overnight lending
• Counterparty risk
• Strains on liquidity
• Shortage of acceptable collateral
• Options include offering liquidity
• At longer maturities
• To a wider set of financial institutions
• Against shakier collateral
• Anonymously

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Provision of liquidity

• May be easy to implement relatively little
  credit risk no market risk reduces risk of bank
  runs if target is bank reserves, policy stance
  is easy to monitor and communicate
• May not translate into credit to real economy if
  financial intermediaries are short of capital and
  seek to deleverage
• All major central banks undertook a variety of
  measures in this category

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Credit Market Intervention

• Purchases of private-sector assets by central
  bank
• Commercial paper, corporate bonds, asset-backed
  securities
• Credit to financial institutions for purchase of
  private securities
• Securities can be used as collateral
• Direct lending to non-financial private sector

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Credit Market Intervention

• May be more effective than going through banks
  when banks are broken
• Signaling value doing all you can
• Can be selective, target particularly important
  and distressed markets
• Presents logistical challenges
• Exposes central bank to credit risk
• Gives central bank role in credit allocation, may
  distort relative prices

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Credit Market Intervention

• U.S. large scale BoE, BoJ, ECB small scale

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Purchase of government bonds

• Aims to flatten yield curve if low policy rates
  and commitment to keep them low does not
  translate into low long rates
• Rates on government bonds are a benchmark for
  pricing many private securities
• Banks can use extra reserves to extend new credit

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Purchase of government bonds

• Familiar operations
• Minimum credit risk
• Some market risk
• May signal commitment to keep accommodative
  policy
• Operate in deep, liquid markets
• Substantial purchases may be needed to move rates
• May have little impact on prices of private,
  risky securities

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Bond Purchase Commitment

• U.S. 300 bn (2 of GDP) by end-October, 2009
• UK 175 bn (12 of GDP) by early November, 2009
• Japan increased purchases to annual rate of
  21.6 trillion (4 of GDP) but net purchases
  are much smaller
• ECB and BoC no bond purchases

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Credit Easing vs. Quantitative Easing

• Quantitative easing refers to outright purchases
  of financial assets through the creation of
  excess settlement balances (that is, central bank
  reserves)
• Credit easing refers to purchases of private
  sector assets in certain credit markets that are
  important to the functioning of the financial
  system but that are temporarily impaired.

Source Bank of Canada
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What accounts for diversity?

• Disagreement on usefulness of explicit commitment
• Differences in country circumstances

• Depth of recession
• Impairment of financial system
• Role of banks
• Institutional arrangements
• Actions of non-monetary authorities

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Effectiveness of Unconventional Policies

• Difficult to ascertain
• Too much is going on at the same time
• What is the counterfactual?
• Substitutability between supported and
  unsupported assets
• What matters announcement or implementation?
• Look at prices and volumes in supported and
  unsupported markets

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Effectiveness

• In our view, liquidity provision and credit
  intervention policies have largely been effective
  in alleviating market stress and facilitating
  flow of credit
• Conditions in financial markets have improved
• Spreads fell more in supported than in
  unsupported markets
• Conforming vs. jumbo mortgages
• High-rated vs. low-rated ABCP
• TALF-eligible ABS vs. HEL ABS
• Volumes picked up and maturity lengthened in ABCP
  markets

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Improvement in broad liquidity indicators and in
markets supported by the central banks
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Effectiveness of government bond purchases is
questionable
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Exit What are the Concerns?

• Banks hold large excess reserves
• Will liquidity translate into fast credit growth
  and inflation?
• Can the central bank control monetary conditions
  with outsized balance sheet?
• Would balance sheet contraction be disruptive?
• Will monetization of government deficits loosen
  fiscal discipline and push up long term yields?
• Loss of central bank independence and credibility

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Exit Can Be Managed

• With large excess capacity, low rates and high
  liquidity will not lead to inflation outburst, as
  long as inflation expectations remain anchored
• Central bank balance sheets will shrink to some
  extent automatically as financial conditions
  improve
• Central banks have adequate tools to control
  monetary conditions even if balance sheets remain
  large
• It is too early to actively tighten monetary
  policy, but exit strategies should be elaborated
  and communicated to the public

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Really?

• Many liquidity and credit market intervention
  facilities are priced above normal market rates
  and will shrink when spreads tighten
• Long-term assets can be sold or will run down as
  they mature
• Ability to pay interest on reserves allows
  central bank control its policy rate even with
  large excess reserves
• For a given size of the balance sheet, reserves
  can be decreased by increasing other liabilities
• Reverse repos
• Government deposits
• Term deposits
• Central bank bills or bonds

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Conclusions

• Unconventional monetary policies were undertaken
  in response to an unprecedented aggregate demand
  shock and strains in the financial markets, such
  that traditional instruments were insufficient to
  deal with the crisis.
• They included enhanced provision of liquidity to
  financial institutions, credit market
  interventions, and, in some cases, purchases of
  government securities and conditional commitment
  to keep policy rate low for an extended period of
  time.
• Their scale and scope varied across countries
  depending on their circumstances.

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Conclusions continued

• Unconventional measures appear to have been
  effective in alleviating market stress and
  boosting aggregate demand.
• Unconventional measures do not imply an outburst
  of inflation down the line. Orderly exit is
  feasible.
• It is to early to actively withdraw
  unconventional interventions, but exit strategy
  should be clearly communicated to the public.

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