Quantitative Easing Period Research Articles

How can a central bank exit quantitative easing without rapidly shrinking its balance sheet?

An important question for the major central banks of the industrialized world is how to design desirable strategies to exit quantitative easing (QE). At the exit, if a central bank needs to reduce rapidly the liquidity created by its balance sheet expansion, issuing new interest-bearing liabilities would be preferable to rapidly shrinking the balance sheet by selling existing assets, both for the stability of those assets' markets and to be able to keep capital losses from being reflected in the balance sheet under amortized-cost accounting. Given that existing assets accumulated during the quantitative easing period have low interest returns, and new liabilities to be issued in the quantitative tightening period would have high interest payouts, the central bank may run a loss that may threaten its solvency, which may force the bank to expand the monetary base above the level that is consistent with the central bank's ideal price stability path. This study considers a central bank that exits QE by issuing liabilities and examines an optimal exit strategy while maintaining the solvency by constructing a simple dynamic optimization model. The model is then applied to the Bank of Japan and the Federal Reserve to examine their possible exits.

Economic policy uncertainty and unconventional monetary policy

AbstractIn this study, the US daily economic policy uncertainty (EPU) index is employed to examine how EPU changes because of the implementation of and exit from the unconventional monetary policy adopted by the Federal Open Market Committee (FOMC). The analysis suggests that forward guidance lowers the volatility of EPU. Moreover, the EPU level decreases during the tapering period of quantitative easing. This may be attributable to the unequivocal expected lifting of the zero interest rate policy. In contrast to these findings favoring the FOMC’s successful communication, it is found that time‐contingent forward guidance increases EPU.

Dynamic Linkages between US Dollar-Ringgit spot, forward and NDF during QE and Post-QE Exit

This study investigates the information flow between U.S. Dollar-Ringgit spot, forward and Nondeliverable Forward (NDF) exchange rates during the pre and post-U. S. Quantitative Easing (QE) exit. Our results show: First, there is a robust unidirectional causality from NDF to spot and NDF to forward in the post-QE period; Second, Malaysian Government Securities (MGS) has a vital role during the QE period while international reserve precedes the spot, forward and NDF exchange rates in the post-US QE exit. Our results reaffirm the policy measures taken by the Central Bank in regulating the NDF market. Our finding suggests that: First: MGS and Reserve are essential variables that can be used to counter speculation from the offshore NDF market; and Second, right policy stance must be communicated by the Central Bank to the market participants to avoid excessive volatility to the domestic currency which will affect the real economy

Implicit Entropic Market Risk-Premium from Interest Rate Derivatives

Implicit in interest rate derivatives are Arrow–Debreu prices (or state price densities, SPDs) that contain funda- mental information for risk and portfolio management in interest rate markets. To extract such information from interest rate derivatives, we propose a nonparametric method to estimate state prices based on the minimization of the Cressie–Read (Entropic) family function between potential SPDs and the empirical probability measure. An empirical application of the method, in the US interest rates and derivatives market, shows that the entropic based risk-neutral density measure highlight potential risks previous to the 2007/2008 financial crisis, and the potential arbitrage burden during the Quantitative Easing period.

Transmission of US and EU Economic Policy Uncertainty Shock to Asian Economies in Bad and Good Times

This study empirically examines the fragility of five major Asian economies (China, Hong Kong, India, Japan, and South Korea) to economic policy uncertainty (EPU) of US and EU, and oil prices in different state of the economies. To investigate these dynamics, we use the relative tail dependence by means of the spillover index of Diebold and Yilmaz (2009, 2012) obtained from Quantile Vector Auto-regressive (QVAR) model, a robust and semi-parametric model, which does not require specification of the full distribution of error terms. The distinguishing feature of our approach from the previous studies is the determination of sign and intensity of asymmetric spillover dynamics from external shocks to Asian economies and variables covering a wide range of macroeconomic aspects. Our results indicate that the spillover indices from EPU and oil price shocks to Asian economies significantly vary across quantiles. The results from sub-sample analysis show that the US EPU has an asymmetric effect on macro variables of China, Hong Kong, and South Korea during the quantitative easing period (QE) and the reverse QE (RQE) periods while the EU EPU makes Asian markets vulnerable during the Eurozone debt crisis. The large-scale asset purchases (LSAPs) of ECB and BoJ seem to reduce Asian market fragilities after 2015. Last but not least, we get partial evidence to support an asymmetric effect of the crude oil shocks on some Asian markets.

Transmission of US and EU Economic Policy Uncertainty Shock to Asian Economies in Bad and Good Times

This study empirically examines the fragility of five major Asian economies (China, Hong Kong, India, Japan, and South Korea) to economic policy uncertainty (EPU) of US and EU, and oil prices in different state of the economies. To investigate these dynamics, we use the relative tail dependence by means of the spillover index of Diebold and Yilmaz (2009, 2012) obtained from Quantile Vector Autoregressive (QVAR) model, a robust and semiparametric model, which does not require specification of the full distribution of error terms. The distinguishing feature of our approach from the previous studies is the determination of sign and intensity of asymmetric spillover dynamics from external shocks to Asian economies and variables covering a wide range of macroeconomic aspects. Our results indicate that the spillover indices from EPU and oil price shocks to Asian economies significantly vary across quantiles. The results from sub-sample analysis show that the US EPU has an asymmetric effect on macro variables of China, Hong Kong, and South Korea during the quantitative easing period (QE) and the reverse QE (RQE) periods while the EU EPU makes Asian markets vulnerable during the Eurozone debt crisis. The large-scale asset purchases (LSAPs) of ECB and BoJ seem to reduce Asian market fragilities after 2015. Last but not least, we get partial evidence to support an asymmetric effect of the crude oil shocks on some Asian markets.

Currency hedging and quantitative easing: Evidence from global bond markets

AbstractWe examine the influence of quantitative easing (QE) in the United States on hedging effectiveness and performance (E&P) of international bond portfolios. During the QE period, the bond portfolios have significantly lower excess returns and variances, and their excess returns (variances) are positive (negative) with the U.S. Federal Reserve's (Fed's) mortgage‐backed securities holdings and are less positive (less negative) with the Fed's Treasury holdings. E&P is higher for optimal versus full hedging during the QE versus pre‐QE period and differs for portfolios from developed and emerging countries. Results are robust using other hedging E&P measures and excluding countries with their own QEs implementations.

Official Demand for U.S. Debt: Implications for U.S. Real Rates

AbstractWe estimate a structural term‐structure model of U.S. real rates, where arbitrageurs accommodate demand pressures exerted by domestic and foreign official investors. Official demand affects rates by altering the aggregate price of duration risk, and thereby bond risk premiums. Although foreign central banks' demand contributed to reduce long‐term real rates mainly in the years prior to the global‐financial crisis, the Federal Reserve's demand lowered rates during the quantitative easing period. Overall, the two‐factor model, augmented to account for changing liquidity conditions, offers a good representation of real rates during the 2001–16 period; however, we flag some caveats and possible extensions.

Modeling the Global Price of Oil 2003-2018: Unintended Consequences of U.S. Quantitative Easing

During the Global Financial Crisis of 2007-2009, the price of crude oil dropped markedly from about $140 per barrel in June 2008 to about $40 in early 2009. As Quantitative Easing allowed the U.S. economy to stabilize and return to slow growth, oil prices increased and averaged about $100 during 2010-13. Then in June 2014, they plunged dramatically to about $40. This paper makes an original contribution that explains the volatile behavior of global crude prices during the 2003-2018 period that includes the Global Financial Crisis. We propose a financial model that focuses on U.S. Quantitative Easing as the signature monetary policy tool to provide liquidity and restore economic growth. This model describes the price of oil as depending on six inputs: Federal Assets accumulated during the period of Quantitative Easing, the 10 Year Treasury Note, the price of copper, the Trade Weighted dollar, the S&P 500 Index and the U.S. High Yield Rate for Bonds rated CCC or below. Making use of 771 overlapping 52-week regressions to capture short run dynamics we find that Quantitative Easing was statistically significant only during 2009-10, while the U.S. High Yield Rate played a significant role explaining oil price changes, both during the crisis and also during the 2014-2017 period. The significance of the U.S. High Yield Rate is expected to continue in the future.

The Effect of U.S. Stress Tests on Monetary Policy Spillovers to Emerging Markets

This paper shows that monetary policy and prudential policies interact. U.S. banks issue more commercial and industrial loans to emerging market borrowers when U.S. monetary policy eases. The effect is less pronounced for banks that are more constrained through the U.S. bank stress tests, reflected in a lower minimum capital ratio in the severely adverse scenario. This suggests that monetary policy spillovers depend on banks’ capital constraints. In particular, during a period of quantitative easing when liquidity is abundant, banks are more flexible, and the scope for adjusting lending is larger when they have a bigger capital buffer. We conjecture that bank lending to emerging markets during the zero-lower bound period would have been even higher had the United States not introduced stress tests for their banks.

The effects of U.S. quantitative easing on South Africa

AbstractThis paper investigates the impact of the Federal Reserve’s monetary policy on the economy of South Africa, particularly during the period of quantitative easing and thereafter from 2009 to 2018. A VAR model, including South Africa’s inflation, output, a stock market index, exchange rate, and South Africa’s policy rate is examined to determine the impact of the Federal Reserve’s actions. Our results show that the Federal Reserve’s quantitative easing programs had only slight overall effects on South Africa’s economy. However, the way monetary policy is measured appears to have important effects for studies of international monetary spillovers as the results differ depending on the type of monetary policy measure used.

THE EFFECTS OF UNCONVENTIONAL MONETARY POLICY IN JAPAN: NEW EVIDENCE FROM TIME-VARYING PARAMETER VAR ANALYSIS

This paper investigates the macroeconomic effects of unconventional monetary policies by estimating a time-varying parameter structural vector auto-regression (TVP-VAR) using Japanese monthly data beginning with the implementation of quantitative easing in 2001. The results of the empirical study can be summarized in four points. First, the impulse responses of output to a positive monetary policy shock rose during the period of quantitative easing (March 2001–July 2006) but declined after the comprehensive monetary easing began (October 2010–July 2015). Second, the impulse responses of inflation to a positive monetary policy shock became stably positive after the introduction of inflation targeting in January 2013. Third, the impulse responses of stock prices to positive monetary policy shocks rose each time an unconventional monetary policy was adopted. Finally, the recovery of the credit transmission channel might be attributed to the level of non-performing loans remaining low. The third result implies that increased stock prices from a monetary policy shock are primarily affected by foreign capital because foreign capital responds more strongly than domestic capital to unconventional monetary policy.

The Effect of U.S. Stress Tests on Monetary Policy Spillovers to Emerging Markets

This paper shows that monetary policy and prudential policies interact. U.S. banks issue more commercial and industrial loans to emerging market borrowers when U.S. monetary policy eases. The effect is less pronounced for banks that are more constrained through the U.S. bank stress tests, reflected in a lower minimum capital ratio in the severely adverse scenario. This suggests that monetary policy spillovers depend on banks? capital constraints. In particular, during a period of quantitative easing when liquidity is abundant, banks are more flexible, and the scope for adjusting lending is larger when they have a bigger capital buffer. We conjecture that bank lending to emerging markets during the zero-lower bound period would have been even higher had the United States not introduced stress tests for their banks.

Expectations and the quantitative easing in Eurozone

The European economy suffered from both the 2008 financial crisis and the debt sovereign crisis of certain of its members and then experienced a period of quantitative easing (QE) starting in 2015. The goal of this study is to explore the direct and exclusive effects of this rather unconventional monetary policy on financial markets, economic activity, and labor markets across the Eurozone. The analysis employs the Markov-switching dynamic regression method. The findings illustrate the reduction of short- and log-term credit spreads, increased stock prices, improved market expectations, recovered labor market conditions and economic productivity, while the primary transmission channel of the QE policy is the expectations channel.

Future of global investing: What is old, what is new, and China's role

The financial crisis was followed by a period of extraordinary monetary policy easing. This period of quantitative easing and zero interest rate policies had significant effects on financial markets and created a global investment environment dominated by a single global factor of central bank policy. Looking forward, “normal” markets should include: (i) higher interest rates, but lower in the steady‐state than pre‐crisis; (ii) greater cross‐country interest differentials; and (iii) lower cross‐asset return correlations. In this environment, idiosyncratic macroeconomic differences across countries matter more than a “risk on/off” global factor that dominated in the post‐crisis era so that the opportunity set for global macro investors should be better than it has been in the 10 years since the crisis. The future investment environment will not be simply that of the pre‐crisis era but will reflect the evolution of the world economy. No single country in this evolution is more important than China and the changes ahead in China will create both risks and opportunities for investors.

Currency Hedging of International Bond Portfolios: Effects of Unconventional Monetary Policy Regimes

We examine the influence of Quantitative Easing (QE) on hedging effectiveness and performance (E&P) of international bond portfolios. During the QE period, the bond portfolios have significantly lower excess returns and variances, and their excess return and variance sensitivities are positive and negative with the Fed's MBS holdings and are less positive and less negative with the Fed's Treasury holdings. E&P are higher for optimal versus full hedging during the QE versus pre-QE period and differ for portfolios from developed and emerging countries. Results are robust using other hedging E&P measures and excluding countries with their own QEs.

Financial market spillovers during the quantitative easing programmes of the global financial crisis (2007–2009) and the European debt crisis

During the recent international global financial and European debt crises, quantitative easing (QE) programmes were implemented, as the last line of defence, to mitigate the intensifying risks of system-wide financial collapse in a host of sovereign states. It has been widely identified that the multiple, and somewhat veiled, side-effects of such actions necessitate further research. We specifically investigate financial market spillovers that took place during the QE programmes of three central banks, namely: the US Federal Reserve, the Bank of England and the European Central Bank. We find evidence of significant idiosyncratic contagion transfer to a number of international financial markets, during each of the three respective QE programmes. The most significant contagion is found to be generated during the United States QE period, primarily with Western European financial markets. Strong internal and international idiosyncratic contagion is observed during the European QE programme.

Time-varying correlations and Sharpe ratios during quantitative easing

Abstract Using an econometric methodology from [Cappiello, Lorenzo, Robert F. Engle, and Kevin Sheppard. 2006. “Asymmetric Dynamics in the Correlations of Global Equity and Bond Returns.” Journal of Financial Econometrics 4 (4): 537–572.], we evaluate time-varying correlations between multiple asset classes using an asymmetric-DCC GARCH model. Specifically, we focus on the changes in these correlations during quantitative easing. We then use these conditional correlations, along with conditional means and variances to find optimal investment portfolios using Markowitz mean-variance minimization. Lastly, we compute time-varying Sharpe ratios. Our results show increasing Sharpe ratios during the period of quantitative easing which suggests that the Federal Reserve’s programs were successful in increasing returns and minimizing risk – i.e. volatility – across several asset classes during the financial crisis.

MONETARY SHOCKS, POLICY TOOLS AND FINANCIAL FIRM STOCK RETURNS: EVIDENCE FROM THE 2008 US QUANTITATIVE EASING

We extend the work of Bernanke and Kuttner [(2005). What explains the stock market’s reaction to federal reserve policy? Journal of Finance, 60, 1221–1257] by examining the impact of monetary shocks and policy tools on aggregate stock returns as well as the stock returns of financial institutions during the recent period of quantitative easing (QE) in the US. Specially, we test for the effectiveness of a major non-conventional monetary policy tool, the use of special asset purchase programs by the Federal Reserve, in impacting the financial markets. Estimates from vector auto-regression (VAR) analyses show that the impact of both unexpected and expected monetary shocks on aggregate stock returns is magnified several times during periods of QE. In addition, traditional monetary policy tools, like the Federal Funds rate, have no impact on aggregate stock returns, neither leading up to, nor during QE, while our non-conventional policy measure does appear to have some impact. In an extension of our results, we find that unexpected monetary shocks have an increased marginal impact on the stock returns of financial firms during QE. In addition, the stock returns of financial institutions have significant reactions to both changes in non-conventional monetary policy tools and announcements surrounding non-conventional policy actions.

EARLY WARNING SYSTEM AND CURRENCY VOLATILITY MANAGEMENT IN EMERGING MARKET

This paper adopts theoretical models from Candelon, Dumitrescu, and Hurlin and empirical model from Commerzbank to devise a set of indicators that can serve as an early warning system (EWS) on exchange rate. In light of the appreciation of emerging countries’ currencies during the Fed quantitative easing period, it is important to understand on how The Fed normalization would put pressure on managing volatility for central banks, especially for countries with large trade and fiscal deficit such as Indonesia. All in all, using both EWS models, central banks could discern potential exchange rate depreciation for intervention purpose.