Asset Purchase Programs Research Articles

Sowing the Seeds of Financial Crises: Endogenous Asset Creation and Adverse Selection

Abstract What sows the seeds of financial crises, and what policies can help avoid them? I model the interaction between the ex-ante production of assets and ex-post adverse selection in financial markets. Positive shocks that increase market prices exacerbate the production of low-quality assets and can increase the likelihood of a financial market collapse. The interest rate and the liquidity premium are endogenous and depend on the functioning of financial markets as well as the total supply of assets (private and public). Optimal policy balances the economy's liquidity needs ex-post with the production incentives ex-ante, and it can be implemented with three instruments: government bonds, asset purchase programs, and transaction taxes. Public liquidity improves incentives but implies a higher deadweight loss than private market interventions. Optimal policy does not rule out private market collapses but mitigates the fluctuations in total liquidity.

Recent Developments in Indian Central Banking: Flying through Turbulence but Aided by Some Tailwinds

This paper, an extension of our earlier work, presents a narrative of select broad aspects of Indian central banking during the pandemic and thereafter. As elsewhere, Indian monetary policy during the pandemic was characterized by substantial monetary expansion both in terms of rate cuts as well as asset purchase programs. The inflation targeting regime of Indian monetary policy was put to severe stress following the spurt in inflation after the pandemic. Besides, there have been two positive developments in Indian central banking. First, there has been significant improvement in the balance sheets of the Indian banking sector, following the institution of an effective corporate bankruptcy regime, write‐offs of earlier stressed assets, and recapitalization of public sector banks by the government. Second, India has made substantial progress in terms of adopting various facets of its digital financial infrastructure, where public initiatives were accompanied by private sector innovations. The digitalization of payments increased in both quantum and value and has touched the lives of the public through the ease of making daily payments, including the smallest of transactions.

Monetary policy spillovers between the US and African Central Banks: A time- and frequency-varying connectedness study

This study investigates time and frequency connectedness between monetary policy in the US and 7 African countries to determine the extent to which US monetary policy influences policy conduct amongst African Central Banks. We use a time-varying parameter vector autoregressive (TVP-VAR) framework with frequencies to extract the spectral representation of the forecast error variance decompositions of the TVP-VAR and form 3 bands of frequency strata corresponding to long-run, medium-run and short-run. The results of the study are as follows: firstly, the static analysis shows that the US is the dominant transmitter of systemic shocks across all frequencies and the vulnerability of African countries as recipients of these shocks varies across frequency bands. Secondly, the dynamic analysis further reveals stronger short- and medium-run systemic connectedness during the periods of the Large Scale Asset Purchase programme and forward guidance policies whereas long-run connectedness is prominent during periods of US conventional monetary policy particularly in the COVID-19 era. The findings from the country-by-country dynamic spillover specifically show that countries which are more (less) responsive to US monetary policy shocks have lower (higher) inflation rates averages since the start of the pandemic. The findings suggest that African Central Banks can be benefit from higher coordination with the US Federal Reserve and we further propose that Central Banks worldwide in setting similar inflation targets.

Zu Risiken und Nebenwirkungen fragen Sie Ihren Arzt oder Notenbanker: Steigende Immobilienpreise infolge der Anleihekäufe des Eurosystems?

Abstract Critics of the Eurosystem’s asset purchase programmes have long cautioned about unintended and undesired side-effects of the programmes. One of these potential side-effects are rising housing prices. There is good reason to assume that the lowering of security yields has lowered mortgage rates which in turn would have boosted demand for properties. Yet, while there is ample evidence that the security purchases have lowered long-term interest rates, the link between the latter and housing prices is looser than may be expected. Housing prices have grown stronger with the Eurosystem’s purchases, but not significantly stronger. Given the serious effects of highly and potentially overvalued housing markets, the ECB and other central banks are still well-advised to assess the side-effects of their policy measures thoroughly.

Carrots with(out) sticks: credit policy and the limits of green central banking

This article considers the role of central bank interventions in credit and financial markets in support of decarbonization. Drawing on the critical macrofinance literature, we argue that central banks are constrained in greening financial flows by their continued adherence to monetary dominance – prioritizing short-term price stability – and the structural demands of global market-based finance. This has led to a narrow focus on 'market-fixing' and 'de-risking' policy interventions, implicitly outsourcing the green transition to private finance whilst asserting that central banks cannot be seen as 'climate policymakers'. Moving beyond the constraints of this macrofinancial regime remains challenging, as we illustrate with the European Central Bank's (ECB) tilting of its corporate asset purchase program. We explore the lessons from the Post-World War II credit guidance regimes employed in many countries and consider how these could be updated to meet the challenges posed by market-based finance. Such a shift would require an evolution in the role of the central bank as a public agency, challenging current norms around independence and market neutrality.

Evaluating the yield curve effects of central bank asset purchases under a forward-looking supply factor

The theoretical literature on term structure models emphasizes the importance of the expected absorption of duration risk during the residual life of term bonds in order to understand the yield curve effect of central banks’ government bond purchases. Motivated by this, we develop a forward-looking, long-horizon measure of euro area government bond supply net of Eurosystem holdings, and use it to estimate the impact of the ECB’s asset purchase programs in the context of a no-arbitrage affine term structure model. We find that an asset purchase shock equivalent to 10% of euro area GDP lowers the 10-year average yield of the euro area big-four by 59 basis points (bp) and the associated term premium by 50 bp. Applying the model to the risk-free (OIS) yield curve, the same shock lowers the 10-year rate and term premium by 35 and 26 bp, respectively.

Same actions, different effects: The conditionality of monetary policy instruments

This paper explores the signaling effect of central bank announcements clarifying the reaction function of policy interventions. We exploit the unique setting provided by ECB asset purchase programs. We find that the same action – purchases of identical assets – undertaken under different titles generates different responses. PSPP affects inflation swaps whereas PEPP impacts sovereign spreads, so that only the variables associated with the communicated rationale of each program react. We highlight the importance of clarifying the conditional path of policy instruments for the transmission of monetary policy. We also provide evidence of this signaling channel from other ECB and BoE announcements.

Heterogeneous macro and financial effects of ECB asset purchase programs

Like other central banks, the ECB resorted to asset purchase programs (APPs) to replace conventional policy measures. We examine their impact on the Euro area with a focus on the heterogeneity among its constituents and across financial markets. Our analysis combines a Bayesian structural VAR with an identification scheme based on market surprises at the announcement time, effectively capturing structural dynamics. At the Euro area level, APPs stimulate the economy, lower government bond yields, elevate stock prices, and reduce corporate and sovereign stress. The impact shows heterogeneity in the stock market with a widened value-growth spread in stocks and varying sector impacts, particularly favoring financial stocks, and across countries with stronger effects on southern Euro area countries. Our results show strong spillover effects between countries, indicating challenges in the precise targeting of APPs.

The economic impact of yield curve compression: Evidence from euro area forward guidance and unconventional monetary policy

Unconventional monetary policies have now been part of the toolkit of developed economy central banks for well over a decade. The question of how their effects have changed over time is therefore an important one. This paper studies the impact of multiple forms of monetary policy surprise for the case of the ECB. I employ a semi-parametric time-varying VAR-X framework, which allows one to chart the changing responses of a broad range of financial and macroeconomic variables simultaneously. I develop high-frequency series that separate forward guidance from yield curve compression surprises — the use of the latter allows one to learn about the effects of flattening yield curves through the history of the ECB, including those induced by its Expanded Asset Purchase Programme (APP). Forward guidance surprises are found to have their maximum impact on inflation when these policies were linked to the duration of the APP. Yield curve compression surprises are shown to transition from largely financial effects on equity markets and risk, to having a greater effect on prices at the time of the APP. However, the maximal effect of the APP on prices is found to occur after its maximal effect at flattening the yield curve, indicating delayed transmission.

Central bank liquidity facilities and market making

Central banks have used asset purchase programs to keep markets operational in times of crisis. We model how central bank asset purchases alleviate dealers' balance-sheet constraints, preventing markets from becoming one sided, improving price efficiency and reducing dealer risk positions. Central banks can fully alleviate dealers' balance-sheet constraints by purchasing assets at their fair value; an action which maximizes welfare when dealers are competitive. However, when there is imperfect competition amongst dealers, a central bank which bears costs from intervening may only purchase assets at a discount. We offer additional analysis on the role of lending programs when dealers have leverage constraints, dealers who are unable to net out all balance sheet costs, and cross-asset impacts from interventions.

Whatever-it-takes policymaking during the pandemic

Central banks across the globe introduced large-scale asset purchase programs to address the unprecedented circumstances experienced during the pandemic. Many of these programs were announced as open-ended to shock-and-awe market participants and restore confidence in financial markets. This paper examines whether these whatever-it-takes announcements had larger effects than announcements with explicit limits on scale. We use a narrative approach to categorize announcements made by twenty-two central banks, and event study, propensity-score-matching, and local projection methods to measure the short-term effects of policy announcements on exchange rates and sovereign bond yields. We find that on average a central bank’s first whatever-it-takes announcement lowers 10-year bond yields by an additional 47 basis points relative to size-limited announcements, suggesting that communication of potential policy scale matters. Our results for yields hold for both advanced and emerging economies, while exchange rates go in opposing directions, muting their response when we group all countries together.

Greener and cheaper: green monetary policy in the era of inflation and high interest rates

In recent years central bankers have devoted increased attention to the question of whether and how to intervene to address the growing environmental and climate crisis. The climate intervention debate gained momentum during a period of low inflation and loose monetary policy in core economies – a time characterised by near zero interest rates and large asset purchase programmes. Since 2021, however, the macroeconomic context has changed. Against this background, the paper analyses the contradictory and problematic nature of the direction monetary policy has taken in reaction to higher inflation. It argues that higher interest rates delay the green transformation by raising the cost of sustainable investments, and that the resulting delay also hampers prospects for achieving price stability. The paper concludes that the present macroeconomic environment demands a ‘greener and cheaper’ monetary policy approach designed to address the environmental and climate crisis and also to simultaneously fight inflation.

Unconventional green

We analyse the effects of the Pandemic Emergency Purchase Programme (PEPP) launched by the ECB after the burst of the Covid-19 pandemic. The effects of the programme were different from the previous asset purchases. The PEPP significantly reduced the yield on bonds that at the same time were eligible to the programme and showed a green label. Via a triple difference estimator, we show that this effect is additional to the outperformance of greens vs non-green bonds that also occurred in the set of non-eligible bonds. All in all, the estimated impact stands at 51 basis points, a value that is significant also from an economic point of view: around 20 per cent of the cost of issuing a bond. From a climate change perspective, this evidence suggests that asset purchase programmes are an effective way of supporting firms financing climate-friendly investments on the bond market. In addition, we find that the issuers that benefitted most from the PEPP improved their ESG performance to a larger extent than other issuers.

Acquitted on the Benefit of Doubt … but not Proven Innocent! The Judgment of the German Federal Constitutional Court on the Next Generation EU Program

Abstract Until recently, the recognition to the European Union of the capacity to borrow from capital markets for spending purposes was considered almost inconceivable without a treaty amendment. When borrowing for spending was authorized under the Next Generation EU program to support the recovery of member states from the unprecedented consequences of the coronavirus, it was immediately faced with the suspicion that the pandemic was being used as a pretext to promote the creation of a fiscal and transfer union by the back door in violation of the principle of conferral. In its NGEU judgment, the German Federal Constitutional Court concluded that the authorization to borrow under the program could not be considered ultra vires. However, the ambiguous and controversial reasoning of the Constitutional Court gives rise to uncertainty as to whether the funding and financing model introduced by the recovery program could be used again in the future, beyond the exceptional circumstances of the pandemic. At the same time, it appears that, in this case, the Constitutional Court applied a considerably more restrained version of its ultra vires review compared to its recent case law on the asset purchase programs of the European Central Bank.

Walking a thin line: a reputational account of green central banking

ABSTRACT In this article, we provide a comparative case study analysis of the differentiated climate change engagement of the Bank of England (BoE), European Central Bank (ECB) and Federal Reserve (Fed). Drawing on semi-structured interviews and a newly composed database of central banker speeches and legislative documents, we argue that climate (in)actions of these central banks are shaped by concerns over their reputation. A broad socio-political consensus on the need for climate change mitigation enabled the BoE and ECB to begin integrating CRFRs into their supervisory frameworks without affecting their socio-political reputation while the carbon bias in their own asset purchase programs compelled both central banks to also start greening their monetary policy to preserve their performative reputation. The Fed’s more cautious moves have been driven by a fear of loss of technical reputation in the face of a growing transnational consensus on the financial stability risks of climate change.

The effect of the European Central Bank’s asset purchase programmes on Spain’s public finances

The effect of the European Central Bank’s asset purchase programmes on Spain’s public finances

EUROPEAN FINANCIAL MARKETS CONNECTEDNESS AND MONETARY POLICY COMMUNICATION STRATEGY:SPILLOVER EFFECTS FOR CENTRAL AND EASTERN EUROPE

This study evaluates the impact of unconventional policy announcements by the European Central Bank (ECB) on the interconnectedness of sovereign credit default swaps (SCDS) markets in the European Union (EU) from 2009 to 2014. The findings suggest that ECB's unconventional policy measures reduced sovereign default risk not only in Eurozone nations but also in Central and Eastern European countries. To investigate the transmission of monetary policy effects across European countries, we employ the Diebold & Yilmaz connectedness framework along with an event-study approach. Our analysis reveals robust evidence of substantial positive spillovers from ECB monetary policy measures to all EU countries, effectively shielding the SCDS market from adverse shocks. Among various policy tools, we observe that asset purchase programs enhance overall connectedness, while mixed policy measures bolster within-cluster connectedness. Furthermore, our results highlight the efficacy of specific monetary policy instruments, indicating that asset purchase programs and quantitative easing are particularly effective in reducing sovereign risk. Keywords: communication strategy, financial markets, monetary policy, sovereign risk, Central and Eastern Europe

Unconventional monetary policy in the Euro area: Impacts on loans, employment, and investment

AbstractUsing a dataset of bank‐ and regional‐level data, we study the effectiveness and heterogeneity of the transmission mechanism of the ECB's large scale asset purchases (LSAPs) to the real economy. Our results indicate that banks more exposed to government debt securities had higher growth of loans and loans relative to total assets than less exposed banks after the asset purchase programme (APP), but not after the pandemic emergency purchase programme (PEPP). Furthermore, our results demonstrate that regions where banks are more exposed to government securities exhibit more favorable outcomes after the APP in GDP, fixed capital formation, unemployment, and compensation of employees than regions with less exposed banks, via the bank lending channel. We argue that banks' exposure to LSAPs targeted assets and their geographical location is an important factor determining the magnitude and heterogeneity of the portfolio rebalancing transmission mechanism to the real economy.

The ECB and the inflation monsters: strategic framing and the responsibility imperative (1998–2023)

ABSTRACT The recent resurgence of inflation in Europe has led the ECB to increase interest rates and phase out asset purchase programmes designed to address the effects of the Great Financial Crisis. This article investigates how the ECB has adjusted its logic of responsibility throughout this series of crises. Using a topic model and in-depth analysis of speeches, we examine the ECB’s strategic framing of linkages related to inflation during three historical periods: the Central Bank Independence (CBI) era (1998–2011), the secular stagnation era (2011–2021), and the new inflation era (2021-). Our findings indicate that modifications made to the CBI’s linkages during the secular stagnation era shaped the ECB’s framing of the new inflation era in a novel way. However, despite acknowledging difficult policy tradeoffs, which they used to downplay in the past, ECB policymakers have continued to reframe its initial imperative of responsibility in the hope of avoiding policy discussions on regime change.

Do financial markets react to emerging economies’ asset purchase program? Evidence from the COVID-19 pandemic period

We employ the daily data on bond yield, stock return, and exchange rate to explore their reaction to the large-scale asset purchase program for 8 emerging market economies during the COVID-19 pandemic period. Using event study analysis, we find that: (1) out of 8 emerging economies, 6 economies’ financial markets react to the asset purchase announcements. (2) Most economies witnessed a rise in stock return, and a fall in the yield rate. (3) 2 economies witnessed currency appreciation, while 3 economies experience currency depreciation. Overall, the asset purchase announcements have a mixed effect on the stock, bond, and foreign exchange markets. Hence, these should be included in the central bank’s toolbox as complementary instruments applied to address certain unprecedented economic circumstances.