Unconventional Monetary Policy in Advanced Economies

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Unconventional Monetary Policy in Advanced EconomiesVladimir Klyuev Research Department International Monetary FundThe 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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OutlineReasons for unconventional policies Unconventional approaches Effectiveness of unconventional policies Exit

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Reasons to go unconventionalLarge 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 policyCommit 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Commitment to low policy ratesAims at anchoring market expectations that monetary stimulus will not be withdrawn until durable recovery is in sight Easy to announce; useful when policy uncertainty is high Effectiveness hinges on credibility; commitment has value only to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 liquidityFrictions 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 liquidityMay 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 InterventionPurchases 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 InterventionMay 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 bondsAims 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 bondsFamiliar 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 CommitmentU.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 EasingQuantitative 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 PoliciesDifficult 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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EffectivenessIn 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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Last Updated: 8th March 2018

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