Interest Rates, Prices and Liquidity

Transcription

1 Interest Rates, Prices and Liquidity Many of the assumptions that underpin mainstream macroeconomic models have been challenged as a result of the traumatic events of the recent financial crisis. Until recently, it was widely agreed that short-term interest rates were a sufficient instrument of monetary policy. However, early on in the financial crisis interest rates effectively hit zero per cent and so central banks had to resort to a set of largely untested instruments, the purchase of financial assets under quantitative easing (QE). This book brings together contributions from economists working in academia, financial markets and central banks to assess the effectiveness of these policy instruments and to explore what lessons have so far been learned. jagjit s. chadha is Professor of Economics at the University of Kent, Canterbury. sean holly is Professional Fellow at Fitzwilliam College and Director of Research at the Faculty of Economics, University of Cambridge.

2 Macroeconomic Policy Making Series editors Professor JAGJIT S. CHADHA University of Kent, Canterbury Professor SEAN HOLLY University of Cambridge The financial crisis has asked some very hard questions of modern macroeconomics. The consensus that grew up during the Great Moderation has proved to be an incomplete explanation for how to conduct monetary policy in the face of financial shocks. This series brings together leading macroeconomic researchers and central bank economists to analyse the tools and methods necessary to meet the challenges of the post- financial crisis world.

3 Interest Rates, Prices and Liquidity Lessons from the Financial Crisis Edited by Jagjit S. Chadha and Sean Holly

4 cambridge university press Cambridge, New York, Melbourne, Madrid, Cape Town, Singapore, São Paulo, Delhi, Tokyo, Mexico City Cambridge University Press The Edinburgh Building, Cambridge CB2 8RU, UK Published in the United States of America by Cambridge University Press, New York Information on this title: / Cambridge University Press 2012 This publication is in copyright. Subject to statutory exception and to the provisions of relevant collective licensing agreements, no reproduction of any part may take place without the written permission of Cambridge University Press. First published 2012 Printed in the United Kingdom at the University Press, Cambridge A catalogue record for this publication is available from the British Library Library of Congress Cataloguing in Publication data Interest rates, prices and liquidity : lessons from the financial crisis / edited by Jagjit S. Chadha, Sean Holly. p. cm. (Macroeconomic policy making) Papers presented at a conference held in Cambridge, England in Mar ISBN (hardback) 1. Interest rates. 2. Monetary policy. 3. Global Financial Crisis, I. Chadha, Jagjit. II. Holly, Sean. III. Title. HG1621.I dc ISBN Hardback Cambridge University Press has no responsibility for the persistence or accuracy of URLs for external or third-party Internet websites referred to in this publication, and does not guarantee that any content on such websites is, or will remain, accurate or appropriate.

5 Contents List of figures List of tables List of contributors page vii ix x 1 New instruments of monetary policy jagjit s. chadha and sea n holly 1 2 Liquidity and monetary policy douglas gale 32 3 Interest rate policies and stability of banking systems hans gersbach and jan wenzelburger 71 4 Handling liquidity shocks: QE and Tobin s q john driffil l and marcus m i ller Asset purchase policies and portfolio balance effects: a DSGE analysis richard harrison Financial intermediaries in an estimated DSGE model for the UK stefania villa and jing yang Central bank balance sheets and long-term forward rates sharon kozic ki, eri c santor an d lena suc hanek Non-standard monetary policy measures and monetary developments domenico giannone, michele lenza, huw pill and lucrezia reichlin QE one year on spen ce r dal e 222 v

6 vi Contents 10 What saved the banks: unconventional monetary or fiscal policy? michael wickens Non-conventional monetary policies: QE and the DSGE literature evren caglar, jagjit s. chadha, jack meaning, jam es warren and alex waters 240 Index 274

7 Figures 1.1 QE in a CC/LM framework page UK policy rate and nominal GDP growth Policy rates Money multiplier CPI and core inflation in Japan Bank of England and Federal Reserve purchases of assets Bank of England s balance sheet assets Bank of England s balance sheet liabilities Uncertainty about asset returns and risk preferences Sectors of the economy Repayments of entrepreneurs Collapse of the banking system Convergence to the consumption trap Resolving a banking crisis Preventing a banking crisis Capital accumulation and real equity prices before and after the 1929 stock market crash Central bank total liabilities in the crisis (August 2007=100) Portfolio balance and zero net investment Liquidity shock shifts equilibrium from E to E : stock market falls in the short run Effect of a liquidity shock that is expected to last for eight quarters Bursting of asset bubble leading to liquidity contraction UK government bond portfolio and yield curve slope Responses to conventional monetary policy shock Responses to purchases of long-term bonds Responses to asset purchase shock Responses to contractionary demand shock 139 vii

8 viii List of figures 5.6 Responses to contractionary demand shock with asset purchase policies Fit of the model The estimated IRFs to a technology shock and to an interest rate shock The estimated IRFs to a shock to the quality of capital and to a shock to bank capital Historical decomposition The estimated IRFs with and without credit policy UK ten-year government bond yields US ten-year Treasury yields US central bank assets and claims to potential GDP Federal Reserve balance sheet assets Behaviour of US money stocks during the Great Depression, Behaviour of euro area money stocks during the financial crisis, Spread between three-month EURIBOR and three-month general collateral (GC) repo rate Eurosystem balance sheet Substitution of central bank intermediation for interbank transactions Eurosystem interest rate corridor and EONIA Comparison of outturns with conditional forecasts in Giannone et al. (2010) model Impact of spread effects of non-standard measures in Lenza et al. (2010) Announcement effects M4x Year-on-year growth of M4x Net non-deposit liabilities Sectoral M4 money holdings Year-on-year growth of money holdings Reserves Sectoral year-on-year growth of M4Lx Impulse responses of the Harrison model Impulse responses of the Gertler Karadi model Impulse responses of the Chadha Corrado model 262

9 Tables 5.1 Parameter values page Some statistical properties of the data ( ) Calibrated parameters Prior and posterior distributions of structural parameters Simulated moments Subsample estimates The importance of the different frictions Baseline results for US regressions Alternative specifications for US regressions (1) Alternative specifications for US regressions (2) Panel regressions MPC announcements regarding the asset purchase programme Types of asset bought with the creation of new reserves (on a settled basis) Announcement dates included in event study Total impact of QE over event study on key variables Balance sheet changes A1 Descriptions and parameter values A2 Parameter descriptions and values A3a Parameter descriptions and values A3b Steady-state parameter descriptions and values 266 ix

10 Contributors EVREN C AGLAR University of Kent, Canterbury JAGJIT S. CH AD HA University of Kent, Canterbury and CIMF, Cambridge SPENCER DALE Bank of England JO HN DRIFFIL L Birkbeck College, University of London DOUGLAS GALE New York University HA N S GER S B A C H Center of Economic Research at ETH Zurich and CEPR European Center for Advanced Research in Economics and Statistics (ECARES) DOMENICO GIANNONE RICHARD HARRISON Bank of England SEAN HO LLY University of Cambridge and CIMF, Cambridge SHARON KOZICKI Bank of Canada MICHELE LENZA European Central Bank JACK MEANING University of Kent, Canterbury MARCUS MILLER University of Warwick HUW P IL L European Central Bank LUCREZIA REICHLIN London Business School ERIC SANTOR Bank of Canada LENA SUCHANEK Bank of Canada STEFANIA VILLA Birkbeck College, University of London JAMES W ARR EN University of Kent, Canterbury x

11 List of contributors xi ALEX WATER S University of Kent, Canterbury JAN WENZELBURGER Keele University MICHAEL WICKENS University of York and Cardiff Business School JING YAN G Bank for International Settlements, formerly Bank of England

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