Unconventional Monetary Policy during the Great Recession: Theory, Empirical Evidence and Limitations. Kilian Rieder 1.

Transcription

1 Unconventional Monetary Policy during the Great Recession: Theory, Empirical Evidence and Limitations Kilian Rieder 1 1 University of Oxford, kilian.rieder@univ.ox.ac.uk Paris Dauphine, London Campus Guest Lecture 10 April 2018 Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

2 Outline 1 Group exercise & plenary discussion: terms and definitions (30min) 2 Motivating unconventional monetary policy (25min) 3 Break (5min) 4 Defining unconventional monetary policy & its channels (30min) 5 Empirical evidence: US, UK, Eurozone (20min) 6 Limitations, risks & consequences (10min) Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

3 Readings Carlin & Soskice (2015). Macroeconomics - Institutions, Instability and the Financial System. OUP. Chapters 3, 5, 7, 13. Special issue of Oxford Review of Economic Policy published in Winter 2012: Bowdler and Radia: the definition and transmission channels of QE Breedon, Chadha and Waters: the theory and empirics of QE Martin and Milas: international evidence on QE Goodhart and Ashworth: limitations of QE Joyce, Tong and Woods (2011). The United Kingdom s quantitative easing policy: design, operation and impact. Bank of England Quarterly Bulletin, no. 3. Gorton and Metrick (2012). Getting up to speed on the financial crisis: a one-weekend reader s guide. Journal of Economic Literature 50(1), p Goodhart (1999). Myths about the Lender of Last Resort. International Finance 2(3), pp Freixas, Parigi and Rochet (2004). The Lender of Last Resort: A 21st century approach. Journal of the European Economic Association 2(6): pp Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

4 Part I: Group exercise & discussion Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

5 Part II: Motivation Why and when do we need UMP? Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

6 Central bank responses to the Great Recession Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

7 Central bank responses to the Great Recession What happened? Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

8 Central bank responses to the Great Recession What happened? Global financial crisis starting in US: Bear Stearns, Lehman etc. Large demand shock: negative output gap, disinflationary pressures Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

9 Central bank responses to the Great Recession What happened? Global financial crisis starting in US: Bear Stearns, Lehman etc. Large demand shock: negative output gap, disinflationary pressures What did central banks do? Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

10 Central bank responses to the Great Recession What happened? Global financial crisis starting in US: Bear Stearns, Lehman etc. Large demand shock: negative output gap, disinflationary pressures What did central banks do? Conventional monetary policy: large interest rate cuts Usual interest decisions: 25 bp Federal Reserve: 50 bp in September 2007, followed by bp every other month until December 2008 Bank of England: starting in gradually in December 2007, big hike of 150 bp in November 2008 ECB: latecomer with first cut in fall 2008 Consequence: interest rates approach level of zero by 2009 Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

11 Central bank responses to the Great Recession What happened? Global financial crisis starting in US: Bear Stearns, Lehman etc. Large demand shock: negative output gap, disinflationary pressures What did central banks do? Conventional monetary policy: large interest rate cuts Usual interest decisions: 25 bp Federal Reserve: 50 bp in September 2007, followed by bp every other month until December 2008 Bank of England: starting in gradually in December 2007, big hike of 150 bp in November 2008 ECB: latecomer with first cut in fall 2008 Consequence: interest rates approach level of zero by 2009 Why did central bank intervene so heavily? Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

12 Central bank responses to the Great Recession What happened? Global financial crisis starting in US: Bear Stearns, Lehman etc. Large demand shock: negative output gap, disinflationary pressures What did central banks do? Conventional monetary policy: large interest rate cuts Usual interest decisions: 25 bp Federal Reserve: 50 bp in September 2007, followed by bp every other month until December 2008 Bank of England: starting in gradually in December 2007, big hike of 150 bp in November 2008 ECB: latecomer with first cut in fall 2008 Consequence: interest rates approach level of zero by 2009 Why did central bank intervene so heavily? Avoid experience of Great Depression Some important lessons from history Policy-makers aware of GD experience Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

13 Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

14 Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

15 Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

16 Running out of ammunition Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

17 Running out of ammunition Situation in 2009/2010: Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

18 Running out of ammunition Situation in 2009/2010: Reaching the zero lower bound of interest rates Still severe contraction, inflation falling European debt crisis reinforces problem in Eurozone Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

19 Running out of ammunition Situation in 2009/2010: Reaching the zero lower bound of interest rates Still severe contraction, inflation falling European debt crisis reinforces problem in Eurozone Why can central banks not cut rates below zero? Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

20 Running out of ammunition Situation in 2009/2010: Reaching the zero lower bound of interest rates Still severe contraction, inflation falling European debt crisis reinforces problem in Eurozone Why can central banks not cut rates below zero? They could, at least in theory Example: Riksbank (Sweden), Swiss National Bank However, negative rates unlikely to be effective everywhere or over LT Negative interest rate: tax on depositors and investors How to avoid it? Hoard cash, e.g. at home in you cellar Why? Your cellar provides an interest rate of zero Limit to hoarding = success of negative rates if storage is costly/dangerous (e.g. insurance) Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

21 Running out of ammunition Situation in 2009/2010: Reaching the zero lower bound of interest rates Still severe contraction, inflation falling European debt crisis reinforces problem in Eurozone Why can central banks not cut rates below zero? They could, at least in theory Example: Riksbank (Sweden), Swiss National Bank However, negative rates unlikely to be effective everywhere or over LT Negative interest rate: tax on depositors and investors How to avoid it? Hoard cash, e.g. at home in you cellar Why? Your cellar provides an interest rate of zero Limit to hoarding = success of negative rates if storage is costly/dangerous (e.g. insurance) Why not just wait and see? Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

22 Running out of ammunition Situation in 2009/2010: Reaching the zero lower bound of interest rates Still severe contraction, inflation falling European debt crisis reinforces problem in Eurozone Why can central banks not cut rates below zero? They could, at least in theory Example: Riksbank (Sweden), Swiss National Bank However, negative rates unlikely to be effective everywhere or over LT Negative interest rate: tax on depositors and investors How to avoid it? Hoard cash, e.g. at home in you cellar Why? Your cellar provides an interest rate of zero Limit to hoarding = success of negative rates if storage is costly/dangerous (e.g. insurance) Why not just wait and see? Large welfare costs: unemployment Deflationary trap Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

23 Deflationary trap (I): background Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

24 Deflationary trap (I): background What does monetary policy normally try to achieve? Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

25 Deflationary trap (I): background What does monetary policy normally try to achieve? Today, central banks try to achieve inflation target Target (π T ) = rate of inflation consistent with equilibrium output and equilibrium unemployment Equilibrium output = no output gap Equilibrium unemployment = unemployment equal to NAIRU Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

26 Deflationary trap (I): background What does monetary policy normally try to achieve? Today, central banks try to achieve inflation target Target (π T ) = rate of inflation consistent with equilibrium output and equilibrium unemployment Equilibrium output = no output gap Equilibrium unemployment = unemployment equal to NAIRU How does conventional monetary policy achieve this? Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

27 Deflationary trap (I): background What does monetary policy normally try to achieve? Today, central banks try to achieve inflation target Target (π T ) = rate of inflation consistent with equilibrium output and equilibrium unemployment Equilibrium output = no output gap Equilibrium unemployment = unemployment equal to NAIRU How does conventional monetary policy achieve this? Changing the nominal interest rate Usually, interbank lending rate is targeted Nominal interest rate influences demand in economy This happens through many channels = transmission channels Demand in economy ultimately influences inflation rate Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

28 Deflationary trap (I): figure from C&S (2015, Chapter 13, p.479) Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

29 Deflationary trap (II) Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

30 Deflationary trap (II) The Fisher equation and its implications Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

31 Deflationary trap (II) The Fisher equation and its implications i = r + π e What matters for economy is r; but CB can only influence i Assuming ZLB, minimum r that can be achieved is r min = π e Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

32 Deflationary trap (II) The Fisher equation and its implications i = r + π e What matters for economy is r; but CB can only influence i Assuming ZLB, minimum r that can be achieved is r min = π e Why does this matter? Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

33 Deflationary trap (II) The Fisher equation and its implications i = r + π e What matters for economy is r; but CB can only influence i Assuming ZLB, minimum r that can be achieved is r min = π e Why does this matter? Scenario: very large demand shock (e.g. Great Recession) r min might not be enough to stabilize economy Rather than recovering, economy spirals away from equilibrium Spiraling away is called deflationary trap Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

34 Deflationary trap (II) The Fisher equation and its implications i = r + π e What matters for economy is r; but CB can only influence i Assuming ZLB, minimum r that can be achieved is r min = π e Why does this matter? Scenario: very large demand shock (e.g. Great Recession) r min might not be enough to stabilize economy Rather than recovering, economy spirals away from equilibrium Spiraling away is called deflationary trap Why does this happen (and where does this term come from)? Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

35 Deflationary trap (II) The Fisher equation and its implications i = r + π e What matters for economy is r; but CB can only influence i Assuming ZLB, minimum r that can be achieved is r min = π e Why does this matter? Scenario: very large demand shock (e.g. Great Recession) r min might not be enough to stabilize economy Rather than recovering, economy spirals away from equilibrium Spiraling away is called deflationary trap Why does this happen (and where does this term come from)? Negative demand shock disinflationary pressure/deflation Consequence: inflation below target If shock is large, r min might not be enough to get back to target r will raise and raise as long as deflationary pressure persists Higher r lower demand reinforcing initial shock Economy is in a deflationary trap (negative spiral) Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

36 Deflationary trap (III) Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

37 Deflationary trap (III) Some notations to illustrate deflationary trap in a figure Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

38 Deflationary trap (III) Some notations to illustrate deflationary trap in a figure Check C & S (2015) chapter 1-3 Curves (=equations) IS curve = reflects demand situation of economy PC curve = reflects feasible output and inflation combinations for given rate of expected inflation MR curve = reflects monetary rule Best response to given output/inflation combination......to get back to target as quickly as possible. Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

39 Deflationary trap (III) Some notations to illustrate deflationary trap in a figure Check C & S (2015) chapter 1-3 Curves (=equations) IS curve = reflects demand situation of economy PC curve = reflects feasible output and inflation combinations for given rate of expected inflation MR curve = reflects monetary rule Best response to given output/inflation combination......to get back to target as quickly as possible. Variables Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

40 Deflationary trap (III) Some notations to illustrate deflationary trap in a figure Check C & S (2015) chapter 1-3 Curves (=equations) IS curve = reflects demand situation of economy PC curve = reflects feasible output and inflation combinations for given rate of expected inflation MR curve = reflects monetary rule Best response to given output/inflation combination......to get back to target as quickly as possible. Variables r real interest rate π inflation, π e expected inflation, π T inflation target y output Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

41 Deflationary trap (III): figure from C&S (2015, Chapter 3, p.106) Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

42 Part III: Defining unconventional monetary policy & its channels Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

43 Definition & aims Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

44 Definition & aims How to get out of deflationary spiral? Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

45 Definition & aims How to get out of deflationary spiral? Fiscal policy is one possibility Fiscal policy shifts IS right, might get economy out of trap......by creating positive output gap However, fiscal space limited in Great Recession (especially in Eurozone) UMP: first and foremost response to deflationary trap Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

46 Definition & aims How to get out of deflationary spiral? Fiscal policy is one possibility Fiscal policy shifts IS right, might get economy out of trap......by creating positive output gap However, fiscal space limited in Great Recession (especially in Eurozone) UMP: first and foremost response to deflationary trap What is UMP? UMP: set of tools rather than a single tool Three main tools used by central banks Forward guidance Balance sheet composition Balance sheet expansion Main idea: since SR rate (i) cannot be brought down further (ZLB)......influence LT rates to boost economy (shift IS right)......or find other additional channels to boost AD. Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

47 Tools (I): overview Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

48 Tools (I): overview Forward guidance Promise to keep rates for long time......to achieve a decrease in LT. Commitment to keep rates low tied to economic outcomes In technical terms: flatten far end of yield curve Problems: Credibility Time inconsistency if commitment to irresponsibility needed Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

49 Tools (I): overview Forward guidance Promise to keep rates for long time......to achieve a decrease in LT. Commitment to keep rates low tied to economic outcomes In technical terms: flatten far end of yield curve Problems: Credibility Time inconsistency if commitment to irresponsibility needed Changes in CB balance sheet composition Freeing bank balance sheets from toxic assets Buying LT bonds Problem: limited to current balance sheet size Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

50 Tools (I): overview Forward guidance Promise to keep rates for long time......to achieve a decrease in LT. Commitment to keep rates low tied to economic outcomes In technical terms: flatten far end of yield curve Problems: Credibility Time inconsistency if commitment to irresponsibility needed Changes in CB balance sheet composition Freeing bank balance sheets from toxic assets Buying LT bonds Problem: limited to current balance sheet size Changing CB balance sheet size: quantitative easing Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

51 Tools (II): focus on quantitative easing Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

52 Tools (II): focus on quantitative easing What is quantitative easing? (Electronic) money creation Created money balances used to purchase assets Counterparties: banks, other FIs etc. Both CB assets and liabilities increase: balance sheet expands helicopter money! Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

53 Tools (II): focus on quantitative easing What is quantitative easing? (Electronic) money creation Created money balances used to purchase assets Counterparties: banks, other FIs etc. Both CB assets and liabilities increase: balance sheet expands helicopter money! What makes QE different from conventional MP? OMOs are also asset purchases, so what is different? Deployed at ZLB only, larger, riskier for CB, broader range of assets Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

54 Tools (II): focus on quantitative easing What is quantitative easing? (Electronic) money creation Created money balances used to purchase assets Counterparties: banks, other FIs etc. Both CB assets and liabilities increase: balance sheet expands helicopter money! What makes QE different from conventional MP? OMOs are also asset purchases, so what is different? Deployed at ZLB only, larger, riskier for CB, broader range of assets How might QE help? Can make forward guidance credible ( expectation channel ) Expands balance sheet size, making composition changes more effective Several direct channels Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

55 Tools (III): some direct transmission channels of QE Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

56 Tools (III): some direct transmission channels of QE Portfolio re-balancing channel QE CB purchases assets seller gets cash/money balance Cash does not yield return seller reinvest money in other assets with higher return Prices on other assets rise (e.g. corporate bonds), while their (yield) interest rate falls Lower (re-)financing costs boost aggregate demand Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

57 Tools (III): some direct transmission channels of QE Portfolio re-balancing channel QE CB purchases assets seller gets cash/money balance Cash does not yield return seller reinvest money in other assets with higher return Prices on other assets rise (e.g. corporate bonds), while their (yield) interest rate falls Lower (re-)financing costs boost aggregate demand Exchange rate channel Economies are usually quite open nowadays Some re-balancing will be into foreign assets Demand for foreign currency, domestic currency depreciates Depreciated FX rate net exports AD Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

58 Tools (III): some direct transmission channels of QE Portfolio re-balancing channel QE CB purchases assets seller gets cash/money balance Cash does not yield return seller reinvest money in other assets with higher return Prices on other assets rise (e.g. corporate bonds), while their (yield) interest rate falls Lower (re-)financing costs boost aggregate demand Exchange rate channel Economies are usually quite open nowadays Some re-balancing will be into foreign assets Demand for foreign currency, domestic currency depreciates Depreciated FX rate net exports AD Fiscal channel QE gov. bond prices Debt service costs for government falls Fiscal tightening more gradual More fiscal space for expansionary policy Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

59 Quantitative easing: figure from C&S (2015, Chapter 13, p.488) Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

60 Part IV: Empirical evidence Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

61 Central bank balance sheet size relative to GDP Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

62 QE had many phases: the US example Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

63 An empirical problem Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

64 An empirical problem How to measure causal effect of QE? We need a comparison case (called counterfactual) Counterfactual: how would economy look like without QE? Problem: we only observe economy QE, not economy no QE Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

65 An empirical problem How to measure causal effect of QE? We need a comparison case (called counterfactual) Counterfactual: how would economy look like without QE? Problem: we only observe economy QE, not economy no QE Illustration of empirical problem: Economic recovery weak in US, UK and particularly in Eurozone Does weak recovery mean QE had no effect? No, we can t tell: may have been much worse without QE Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

66 An empirical problem How to measure causal effect of QE? We need a comparison case (called counterfactual) Counterfactual: how would economy look like without QE? Problem: we only observe economy QE, not economy no QE Illustration of empirical problem: Economic recovery weak in US, UK and particularly in Eurozone Does weak recovery mean QE had no effect? No, we can t tell: may have been much worse without QE How can we investigate QE s effects then? Natural experiments: e.g. similar asset classes, only one subject to QE Produce an artificial counterfactual: synthetic control case Focus on descriptive evidence re: channels (correlation) Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

67 A survey of indicators Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

68 A survey of indicators Positive signs Stock market boom Firms issue record sum of corporate bonds US: inflation and inflationary expectations up, no deflation FX depreciates: Sterling and Dollar apparently react to QE Government bond yields low despite ever higher debt stocks (in some cases) Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

69 A survey of indicators Positive signs Stock market boom Firms issue record sum of corporate bonds US: inflation and inflationary expectations up, no deflation FX depreciates: Sterling and Dollar apparently react to QE Government bond yields low despite ever higher debt stocks (in some cases) Negative signs Bank lending remains subdued, especially in UK and Eurozone Some evidence that lower refinancing costs are used to build cash reserves rather than I Japanese experience not particularly encouraging Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

70 Impact of QE: Japan and US (Williamson 2017) Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

71 Impact of QE - US 10-year treasury yields Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

72 Impact of QE - FX rates Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

73 Impact of QE - Bank of England (Bridges and Thomas, 2012) Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

74 Impact of QE - Eurozone (LT rates) Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

75 Impact of QE - Eurozone (Financing conditions) Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

76 Impact of QE - Eurozone (Sovereign bond yields) Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

77 Part V: Limitations, risks & consequences Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

78 Limitations of QE Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

79 Limitations of QE Channels might not work Example: portfolio rebalacing channel Regulatory constraints Lower financing costs used to boost private sector profit, not I Response by banking system crucial More generally: buying assets might help sellers, but not the small guys (no further transmission to real economy) Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

80 Limitations of QE Channels might not work Example: portfolio rebalacing channel Regulatory constraints Lower financing costs used to boost private sector profit, not I Response by banking system crucial More generally: buying assets might help sellers, but not the small guys (no further transmission to real economy) Channels might have perverse effects Example: fiscal channel Lower yields on gov. bonds puts pressure on institutional investors Pension funds generate less revenues Might trigger negative income effect Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

81 Limitations of QE Channels might not work Example: portfolio rebalacing channel Regulatory constraints Lower financing costs used to boost private sector profit, not I Response by banking system crucial More generally: buying assets might help sellers, but not the small guys (no further transmission to real economy) Channels might have perverse effects Example: fiscal channel Lower yields on gov. bonds puts pressure on institutional investors Pension funds generate less revenues Might trigger negative income effect More radical critique: irrelevance proposition of QE Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

82 Risks of QE Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

83 Risks of QE QE is highly controversial although CB have faith in policy Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

84 Risks of QE QE is highly controversial although CB have faith in policy Inflation risk What if recovery comes? Will inflation sky-rocket? Exit options necessary (c.f. further below) Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

85 Risks of QE QE is highly controversial although CB have faith in policy Inflation risk What if recovery comes? Will inflation sky-rocket? Exit options necessary (c.f. further below) Crisis risk Financial institutions receive large amounts of liquidity Thwarting restructuring and resolution of inviable institutions Moral hazard? QE could also be fueling asset price bubbles and overheating Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

86 Risks of QE QE is highly controversial although CB have faith in policy Inflation risk What if recovery comes? Will inflation sky-rocket? Exit options necessary (c.f. further below) Crisis risk Financial institutions receive large amounts of liquidity Thwarting restructuring and resolution of inviable institutions Moral hazard? QE could also be fueling asset price bubbles and overheating Risk of losses Buying at high prices, but selling at low ones? c.f. irrelevance proposition If CB losses are assumed by Treasury, potential fiscal tightening Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

87 Risks of QE QE is highly controversial although CB have faith in policy Inflation risk What if recovery comes? Will inflation sky-rocket? Exit options necessary (c.f. further below) Crisis risk Financial institutions receive large amounts of liquidity Thwarting restructuring and resolution of inviable institutions Moral hazard? QE could also be fueling asset price bubbles and overheating Risk of losses Buying at high prices, but selling at low ones? c.f. irrelevance proposition If CB losses are assumed by Treasury, potential fiscal tightening Threat to central bank independence: QE blurs fiscal and MP Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

88 Risks of QE QE is highly controversial although CB have faith in policy Inflation risk What if recovery comes? Will inflation sky-rocket? Exit options necessary (c.f. further below) Crisis risk Financial institutions receive large amounts of liquidity Thwarting restructuring and resolution of inviable institutions Moral hazard? QE could also be fueling asset price bubbles and overheating Risk of losses Buying at high prices, but selling at low ones? c.f. irrelevance proposition If CB losses are assumed by Treasury, potential fiscal tightening Threat to central bank independence: QE blurs fiscal and MP Threat to central bank transparency: e.g. no clear plan for exit Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

89 How to best exit/unwind QE? Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

90 How to best exit/unwind QE? All these limitations and risks beg question of exit when necessary Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

91 How to best exit/unwind QE? All these limitations and risks beg question of exit when necessary Self-liquidation (maturing debt) solves part of problem......but many long-term securities were bought. Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

92 How to best exit/unwind QE? All these limitations and risks beg question of exit when necessary Self-liquidation (maturing debt) solves part of problem......but many long-term securities were bought. Some possibilities: Reverse QE: open market sales caveats: Price impacts, need to be gradual Might not be always possible (depends on asset types) Raise policy rate (stop bubble/boom) caveats: Might have to be substantial Leaning against the wind can have large costs Innovation: issuing CB bonds caveats: Never used before Rieder (Oxford) Unconventional Monetary Policy 10 April / 37

93 How to best exit/unwind QE? All these limitations and risks beg question of exit when necessary Self-liquidation (maturing debt) solves part of problem......but many long-term securities were bought. Some possibilities: Reverse QE: open market sales caveats: Price impacts, need to be gradual Might not be always possible (depends on asset types) Raise policy rate (stop bubble/boom) caveats: Might have to be substantial Leaning against the wind can have large costs Innovation: issuing CB bonds caveats: Never used before Overall, still an open question Rieder (Oxford) Unconventional Monetary Policy 10 April / 37