Large-scale Asset Purchases Research Articles

The effects of U.S. monetary policy shocks on mutual fund investing

We study the effects of unexpected changes in the stance of U.S. monetary policy on the performance and flows of mutual funds investing in domestic and international financial markets over the recent period of unconventional monetary policy. Taking an agnostic approach on the transmission mechanism of monetary policy, we find that monetary policy shocks have a direct effect on fund performance and flow dynamics, and that the effect of these surprises differs by investment strategy. Results show that an unexpected tightening of the stance of policy is associated with negative performance and outflows from fixed-income funds, in particular those investing in international, government and investment grade bond markets. Results also point to a negative relationship between equity fund performance and policy tightening. Moreover, our findings indicate that Federal Reserve’s expansionary balance sheet policy (i.e. large-scale asset purchases) has a strong positive effect on the performance and flows of equity funds, especially on those investing in emerging markets.

Asset market frictions, household heterogeneity, and the liquidity theory of the term structure

We study the channels through which monetary policy influences the term premium in a general equilibrium model. The idiosyncratic liquidity demand shock and asset market participation shock generate liquidation and reinvestment risks regarding bond holdings, and the term premium can be positive or negative depending on the relative strength of the two risks. An increase in the supply of any bond increases the interest rate of all maturities; this enhances the reinvestment risk but weakens the liquidation risk. Through this “liquidity channel,” a negative relationship between the interest rates and the term premium is generated, and the term premium becomes negative when the interest rates are sufficiently high. Moreover, households having different characteristics such as time discount rates and asset market participation rates demand different term premia, and this generates an endogenous market segmentation. Through this “heterogeneity channel,” the large-scale asset purchases program can effectively decrease the term premium at the zero lower bound. Further, the channel is more effective when the households have a greater variance in their characteristics.

Causal Effects of the Fed's Large-Scale Asset Purchases on Firms' Capital Structure

Causal Effects of the Fed's Large-Scale Asset Purchases on Firms' Capital Structure

Liquidity in the German Corporate Bond Market: Has The Cspp Made a Difference?

The Eurosystem purchased €178 billion of corporate bonds between June 2016 and December 2018 under the Corporate Sector Purchase Programme (CSPP). Did these purchases lead to a deterioration of liquidity conditions in the corporate bond market, thus raising concerns about unintended consequences of large-scale asset purchases? To answer this question, we combine the Bundesbank’s detailed CSPP purchase records with a range of liquidity indicators for both purchased and nonpurchased bonds. We find that while the flow of purchases supported secondary market liquidity, liquidity conditions deteriorated in the long-run as the Bundesbank reduced the stock of corporate bonds available for trading in the secondary market.

Counteracting Large-Scale Asset Purchase Program: The Bank of Japan's ETF Purchases and Securities Lending

This study investigates the impact of the Bank of Japan’s (BOJ) exchange traded fund (ETF) purchasing program on the stock lending market. In particular, we focus on the fact that stocks held by ETF managers for the BOJ are lendable to other investors in order for them to make a short position in stock market. Using individual stock level data, we show that expansions of the ETF purchase program have substantially increased the supply of stocks in the lending market by changing the behavior of stock holders as the BOJ is expected to be a “buy-and-hold” type of investor. This result implies that such an active stock lending market would help to reduce the side-effects of the ETF program whereas the squeezing effect of the program on supply-demand balance in spot stock markets is mitigated.

Spillovers of US unconventional monetary policy: quantitative easing, spreads, and international financial markets

This study investigates the international spillover effects of US unconventional monetary policy (UMP)—frequently called large-scale asset purchases or quantitative easing (QE)—on advanced and emerging market economies, using structural vector autoregressive models with high-frequency daily data. Blinder (Federal Reserve Bank of St. Louis Rev 92(6): 465–479, 2010) argued that the QE measures primarily aim to reduce US interest rate spreads, such as term and risk premiums. Considering this argument and recent empirical evidence, we use two spreads as indicators of US UMP: the mortgage and term spreads. Based on data from 20 emerging and 20 advanced countries, our empirical findings reveal that US unconventional monetary policies significantly affect financial conditions in emerging and advanced countries by altering the risk-taking behavior of investors. This result suggests that the risk-taking channel plays an important role in transmitting the effects of these policies to the rest of the world. The extent of these effects depends on the type of QE measures. QE measures such as purchases of private sector securities that lower the US mortgage spread exert stronger and more significant spillover effects on international financial markets than those that reduce the US term spread. Furthermore, the estimated financial spillovers vary substantially across countries and between and within the emerging and advanced countries that we examine in this study.

Does quantitative easing affect market liquidity?

We argue that central bank large-scale asset purchases—commonly known as quantitative easing (QE)—can reduce priced frictions to trading through a liquidity channel that operates by temporarily increasing the bargaining power of sellers in the market for the targeted securities. For evidence we analyze how the Federal Reserve’s second QE program that included purchases of Treasury inflation-protected securities (TIPS) affected a measure of liquidity premiums in TIPS yields and inflation swap rates. We find that, for the duration of the program, the liquidity premium measure averaged about 10 basis points lower than expected. This suggests that QE can improve market liquidity.

Dynamic Impact of Unconventional Monetary Policy on International REITs

In this paper, we estimate the dynamic impact of unconventional monetary policy in the US on international REITs. Unlike existing studies which are limited to conventional policy tools and undertake a static approach, we use an event study approach and estimate a time-varying parameter model to investigate the dynamic impact of forward guidance (FG) and large-scale asset purchases (LSAP) shocks on the international REIT returns. We also compare the effects of these unconventional tools with the effects of conventional federal funds rate (FFR) shocks. The results show that the response of international REITs to unconventional policy shocks depends on the time under consideration. FG shocks have greater time-variation in the impact on REIT returns compared to LSAP shocks, particularly with Australia, Belgium, and the US REIT markets. Furthermore, FG shocks broadly have a negative impact on REITs while the results for LSAP effects are mixed. We also find that in most countries, REITs time-varying response of FG shocks is related to changes in gold prices and financial conditions.

The growing impact of US monetary policy on emerging financial markets: Evidence from India

Much research has been devoted to studying the international spillover effects of US monetary policy. However, a lot of the focus has been on the recent unconventional monetary policies undertaken by the Federal Reserve. Combining high frequency financial market data with a time-varying parameter approach we show that US monetary policy decisions have had significant effects on the Indian stock markets well before the use of unconventional policy tools and that these effects have gotten stronger over time. In addition to the conventional channel of surprise changes in the policy rate, we find that US monetary shocks are also transmitted through an uncertainty channel, which is especially important for announcements about large scale asset purchases (quantitative easing). Using firm level stock prices, we also show that the higher sensitivity of the aggregate response is uniform across the stock market and is not driven by the increased exposure of any specific industry to US monetary policy. Instead, our results suggest that it is driven by the portfolio decisions of foreign institutional investors, the exchange rate becoming more sensitive to US monetary policy and the global financial cycle working through volatility and risk aversion.

Monetary policy shocks identified using the entire yield curve: an alternative approach

ABSTRACT Conventional monetary policy (MP) shocks are typically identified as unexpected changes in the short end of the yield curve. During the zero lower-bound period, central banks attempt to provide stimulus by operating on the long end of the yield curve with new tools, such as forward guidance and large-scale asset purchase. This implies that the identification of MP shocks should be done throughout the entire yield curve. This study proposes an alternative approach to analysing the effects of MP shocks, using factor-augmented vector autoregression (FAVAR) of monthly data. We therefore used information from large datasets and made changes over the entire yield curve as shocks to the VAR, which were identified using external high-frequency instruments. Furthermore, empirical analyses using economic and financial variables showed that contractionary yield curve changes decrease the inflation rate and increase risk aversion and uncertainty, which is consistent with conventional wisdom.

Macroeconomic stabilisation and monetary policy effectiveness in a low-interest-rate environment

The secular decline in the equilibrium real interest rate observed over the past decades has materially limited the room for policy-rate reductions in recessions, and has led to a marked increase in the incidence of episodes where policy rates are likely to be at, or near, the effective lower bound on nominal interest rates. Using the ECB’s New Area-Wide Model, we show that, if unaddressed, the effective lower bound can cause substantial costs in terms of worsened macroeconomic performance, as reflected in negative biases in inflation and economic activity, as well as heightened macroeconomic volatility. These costs can be mitigated by the use of nonstandard instruments, notably the joint use of interest-rate forward guidance and large-scale asset purchases. When considering alternatives to inflation targeting, we find that make-up strategies such as price-level targeting and average-inflation targeting can, if they are well-understood by the private sector, largely undo the negative biases and heightened volatility induced by the effective lower bound.

Use of the Federal Reserve's repo operations and changes in dealer balance sheets

<ns3:p>Before the 2008 financial crisis, the Federal Reserve (Fed) regularly conducted repurchase agreements (repos) in a fairly modest size with primary dealers to adjust the supply of reserves in the banking system and to keep the federal funds rate at the target set by the FOMC. During the economic downturn that followed the financial crisis, the Fed engaged in large scale asset purchases in order to provide additional monetary accommodation, and those purchases significantly increased the supply of reserves and eliminated the need for the Fed to engage in repo operations to increase reserves in the system.</ns3:p>

Managing the Dollar Over Its Cycles

The United States has ceded to the rest of the world managing the dollar’s value. For a generation, the U.S. authorities have all but withdrawn from the foreign exchange market. Yet the dollar does not float freely as a result of this hands-off U.S. policy. Instead, other authorities manage the dollar exchange rates, albeit separately. These authorities make heavier purchases of dollars in its downswings than in the upswings, damping its decline. Thus, the Fed finds that accommodative monetary policy transmits less to U.S. manufacturing and traded services, and relies on still lower rates to stimulate interest-sensitive housing and auto demand. The current U.S. dollar policy of naming and shaming surplus-running countries accumulating foreign exchange reserves does not seem to work. Three alternatives warrant consideration. First, the U.S. could reinstate its withholding tax on interest income received by non-residents and even add policy criteria to bilateral tax treaties. Second, the U.S. authorities could retaliate by selling dollars against the currencies of dollar-buying jurisdictions running chronic surpluses. However, either the withholding tax or such retaliatory foreign exchange intervention pose huge practical challenges. Third, the U.S. authorities could re-enter the foreign exchange market, making large-scale asset purchases in foreign currency when the dollar rises sharply against its average value. Such a policy would encourage private investment in U.S. traded goods and service production. The challenge is to set ex ante foreign exchange intervention rules to guide market participants’ expectations, even positioning them to do the authorities’ work.

The Effect of Large Scale Asset Purchases in 2020 on Bank Lending

The paper estimates the effect of large scale asset purchases by the Federal Reserve System on bank lending in 2020. The identification strategy exploits the cross-sectional variation in treasury and mortgage-backed security holdings in the bank balance sheet. The identification strategy used is augmented inverse propensity weighing to get unbiased, consistent and efficient estimates. The results show that large scale asset purchases reduced total lending by 0.23% and increased riskier commercial and industrial lending by up to 0.85% and real estate lending by up to 1.38%.

A Model of Endogenous Risk Intolerance and LSAPs: Asset Prices and Aggregate Demand in a “COVID-19” Shock

We theoretically investigate the interaction of endogenous risk intolerance and monetary policy following a large recessionary shock. As asset prices dip, risk-tolerant agents’ wealth share declines. This decline reduces the market’s risk tolerance and triggers a downward loop in asset prices and aggregate demand when the interest rate policy is constrained. In this context, large-scale asset purchases are effective because they transfer unwanted risk to the government’s balance sheet. These effects are sizable when the model is calibrated to match the estimates of aggregate asset demand inelasticity. The COVID-19 shock illustrates the environment we seek to capture.

The non-linear effects of the Fed asset purchases

Abstract The Federal Reserve responded to the great financial crisis deploying new monetary policy tools, the most notable of which being the expansion of its balance sheet. In a recent paper, Weale, M., and T. Wieladek. 2016. “What Are the Macroeconomic Effects of Asset Purchases?” Journal of Monetary Economics 79 (C): 81–93 show that the asset purchases were effective in stimulating economic activity as well as inflation and asset prices. Here I show that their results are state dependent: large scale asset purchase are effective only when financial markets are impaired. Financial markets are under stress when the effective risk-bearing capacity of the financial sector is drastically reduced, i.e. when the excess bond premium (EBP) of Gilchrist, S., and E. Zakrajšek. 2012. “Credit Spreads and Business Cycle Fluctuations.” The American Economic Review 102 (4): 1692–72 exceed a certain threshold. Using an estimated threshold vector autoregressive model conditional on the EBP regime, I show that an increase in the balance sheet has expansionary effects on GDP and inflation when EBP is high, but not when it is low (as its effects become mostly insignificant). I argue that the high EBP can be interpreted as a proxy of market dis-functioning so that only when this channel of transmission is on, the unconventional policy is particularly effective. This suggests that models of transmission of unconventional policies, based on asset purchases, should focus also on the market functioning channel and not only on the portfolio balance one.

How You Say It Matters: Text Analysis of FOMC Statements Using Natural Language Processing

The Federal Reserve has increasingly used public statements to shape expectations about future policy actions. After the Great Recession, when the nominal short-term interest rate reached its effective lower bound, the Federal Open Market Committee turned toward explicit forward guidance about the future path of the policy rate as well as the amount and composition of large-scale asset purchases in their post-meeting statements. Although these statements sometimes included quantitative information, they also included more nuanced, qualitative descriptions of economic conditions. However, measuring the effects of these qualitative communications is not straightforward. Taeyoung Doh, Sungil Kim, and Shu-Kuei Yang use a natural language processing tool to provide a new measure of how changes in qualitative descriptions of the economy in post-meeting statements affect bond prices. They find that qualitative descriptions of economic conditions and the balance of risk can have as much of an effect on bond prices as quantitative information about the target policy rate. In some cases, the tone of the Committee’s statement can affect financial market conditions even if no policy action is taken. Their new measure is generally correlated with alternative measures in prior research based solely on bond price data, and particularly well correlated with medium-term policy expectations.

Unconventional monetary policy and the portfolio choice of international mutual funds

This paper analyses how unconventional monetary policy by the major central banks in developed markets affects the geographical portfolio choice of international mutual fund managers. We find that large-scale asset purchases have significant international spillover effects, in contrast to unconventional monetary policy announcement surprises. Specifically, we document that mutual fund managers rebalance their portfolios away from the developed country conducting large-scale asset purchases and towards other developed markets. We find little evidence for fund managers contributing to QE-induced capital flows to emerging markets.

Unconventional Monetary Policies and Expectations on Economic Variables

We investigate whether forward guidance and large scale asset purchases are effective in steering economic expectations in the US. Using the series of monetary policy shocks recovered in Swanson (2020), local projections, and an algorithm to select the best empirical model, we show that unconventional monetary policies are effective in tilting economic expectations in a direction consistent with central bankers' will. Our empirical findings provide two more insights: responses to LSAP shocks are stronger than those following a FG shock; responses to both types of policies are larger after contractionary shocks as compared to expansionary ones.

Macroeconomic stabilisation and monetary policy effectiveness in a low-interest-rate environment

The secular decline in the equilibrium real interest rate observed over the past decades has materially limited the room for policy-rate reductions in recessions, and has led to a marked increase in the incidence of episodes where policy rates are likely to be at, or near, the effective lower bound on nominal interest rates. Using the ECB's New Area-Wide Model, we show that, if unaddressed, the effective lower bound can cause substantial costs in terms of worsened macroeconomic performance, as reflected in negative biases in inflation and economic activity, as well as heightened macroeconomic volatility. These costs can be mitigated by the use of nonstandard instruments, notably the joint use of interest-rate forward guidance and large-scale asset purchases. When considering alternatives to inflation targeting, we find that make-up strategies such as price-level targeting and average-inflation targeting can, if they are well-understood by the private sector, largely undo the negative biases and heightened volatility induced by the effective lower bound.