Unconventional Monetary Policy Research Articles

Monetary policy and bubbles in G7 economies using a panel VAR approach: Implications for sustainable development

We use the LPPLS Multi-Scale Confidence Indicator approach to detect both positive and negative bubbles in the short-, medium- and long-run for the stock markets of the G7 countries. We were able to detect major crashes and rallies in the seven stock markets over the monthly period of 1973:02 to 2020:09. We also observed similar timing of strong (positive and negative) LPPLS indicator values across the G7 countries, suggesting synchronized extreme movements in these stock markets. Given this, to obtain an overall picture of the G7, we used a panel VAR model to analyze the impact of monetary policy shocks on the six indicators of bubbles. We found that monetary policy not only impacts the bubble indicators but also responds to them, with the nature of the underlying responses contingent on whether bubbles are positive or negative in nature, as well as the time-scale we are analyzing. In light of these findings, our results have serious implications for monetary authorities of these advanced markets in terms of sustainable development, given the finance-growth nexus. But in general, we can conclude that central banks of the G7 can indeed “lean against the wind”, and they have also been doing so under both conventional and unconventional monetary policy periods.

Debt Cancellation to Avert Fiscal Austerity: Helpful Beyond Controversy?

ABSTRACT In 2021, a group of economists launched a proposal asking for the write-off of the public debt built-up in the ECB’s balance sheet and an increase in public spending for a similar amount. This proposal generated strong criticism, which can be organized into three blocks: (i) debt relief occurs when a central bank purchases public debt, and its cancellation does not improve the situation faced by governments; (ii) the proposal is grounded in an erroneous concept of ‘fiscal space’, and there are better alternatives for the financing of public spending; (iii) the proposal would be counterproductive or illegal. This article rebuts those criticisms, finding the plan helpful to avoid a return to fiscal austerity. More specifically, debt cancellation makes quantitative easing, the unconventional monetary policy that justified the purchase of public debt, irreversible whilst simultaneously increasing the fiscal space of Eurozone Member States. Finally, and most relevant, the proposal includes a specific commitment to an increase in public spending.

Business cycles, stock returns and the transmission channels of conventional and unconventional monetary policy

ABSTRACT The zero-lower bound (ZLB) may constrain the ability of Federal Reserve (Fed) to influence financial markets and the economy. This note examines the effectiveness of the interest rate channel and the credit channel of conventional and unconventional monetary policy while accounting for business cycle fluctuations. We use intraday industry returns and a number of industry-specific and firm-specific indicators to capture the sensitivity of firms’ demand to interest rates (interest rate channel) and firms’ financial constraints (credit channel). Our results indicate a dramatic change in the effectiveness of the transmission channels across business cycles and across periods. We find that the interest rate channel operates equally well during recessions and expansions pre-ZLB, but that this channel has ceased to function during the ZLB regardless of the stage of the business cycle. In contrast, the credit channel operates only during recessions in the conventional period, while it has been remarkably effective during both recessions and expansions in the ZLB era. 1 1 We thank Stefania D’Amico, Emmanuel Lartey, Lin Yan, and conference participants of the Econometric Society Asia Meeting 2021, WEAI 2021, World Finance Conference 2022, and International Finance and Banking Society 2018 for helpful comments and suggestions. We gratefully acknowledge the support of the Faculty Research Grant of the College of Business and Economics, California State University, Fullerton.

Do agricultural prices respond to interest on reserves?

This paper elucidates the responsiveness of agricultural commodity prices to changes in interest on reserves, an unconventional monetary policy. It uses a vector autoregression model on monthly data for the United States, from October 2008 to July 2019. The empirical findings show that an increase in the interest rate on reserves leads to a drop in the price of corn, sorghum, and cotton. An increase in the interest on reserves declines the money supply, which increases the real interest rate and makes bonds lucrative over alternative investments such as agricultural commodities. This depresses the farm commodity prices, and the effect reaches its maximum after nearly four months. However, the impact on wheat prices is relatively weak. The estimations are robust to alternate specifications. The results of this study confirm the strong linkage between money supply and the prices of agricultural commodities. Food security for those nations that are heavily dependent on imported food grain from the U.S. market are dependent on the U.S. monetary policy.

When should central banks engage in private sector securities purchases?

Purpose The authors aim to look at the conditions under which central bank easing – and specifically the purchase of private sector securities – can/should contribute to growth, rather than fiscal policy and also ask when can the central bank’s purchase of private sector securities help supplant traditional monetary policy.Design/methodology/approachAfter surveying the existing literature, the authors use simple correlation of central bank private asset (stocks, bonds, etc.), interest rates, gross domestic product (GDP) growth, inflation and the extent of the functioning of domestic banking sectors (among others) to classify countries in which these purchases promote pro-growth investment.FindingsUnder the typical conditions for unconventional monetary policy, central bank purchases of private companies’ securities can promote growth in some places (like Bulgaria, the Ukraine, Georgia and Greece at the time of our writing) while hurting it in others (like in parts of Latin America and Africa in the mid-2010s). The authors find how such purchases effectively “bypass” dysfunctional banking systems and central/government local bodies fiscal spending, making the central bank the “funder of last resort” in many middle and lower income countries.Practical implicationsThis paper tells specific central banks to ramp up – or reduce – their purchases of private sector securities. The authors identify exact jurisdictions where such “helicopter money” has led to investment in the past economic growth.Originality/valueAll previous work on conventional and unconventional monetary policy has looked at the way monetary policy affects investment and growth through the banking system and holding companies’ reactions constant. The authors do the opposite – looking at how companies respond, holding banking system responses constant. No one has ever looked at these private purchases (taken from a special IMF database), much less tried to argue that central banks can sometimes target investment growth much better than fiscal policy. No one has ever considered them as a funder (rather than lender) of last resort.

Unconventional, conventional monetary policies, and optimal energy supply structure in China

This work quantifies the macroeconomic effects of an unconventional monetary policy–targeted refinancing, and a conventional monetary policy–general refinancing on the optimization of the energy supply structure using a dynamic stochastic general equilibrium model. The results show that targeted refinancing exclusively increases bank loans to the green energy sector with lower interest rates, which promotes the energy transition. In contrast, with general refinancing, fossil energy loans increase significantly, leading to higher outputs, while green sector outputs are negatively impacted. Our findings provide novel evidence of the differential effects of unconventional and conventional monetary policies on the energy supply structure.

Spillover effects of the unconventional monetary policy of the European Central Bank

We analyze the effects of the European Central Bank’s (ECB) unconventional monetary policy spillovers on the inflation-targeting Central Eastern European (CEE) countries using daily panel data from 2000 to 2019. We perform an exercise to identify these spillovers on the monetary market, calculate instantaneous short rates and term spreads, and use both Bayesian averaging panel and time-series approaches. Overall, we find that the spillovers from the unconventional ECB policy are not different from the conventional spillovers and are generally insignificant. While we find a significant reaction to inflation and an insignificant reaction to the output gap, we find that none of our ECB policy measures affect the instantaneous short interest rate nor the long-run term spreads. Our main result is that the international spillovers manifest themselves through the risk-taking channel, not the bond/interest rate channel, and have the form of volatility co-movement.

Effectiveness of Unconventional Monetary Policy Tools on Financial Stability: A NARDL Approach for Turkey

The primary purpose of central banks is to achieve and maintain price stability. Until the global financial crisis in 2008, it was accepted that financial stability was achieved in an economy where price stability was achieved. However, after the crisis, it was seen that financial stability could not be achieved in economies where price stability was achieved, and alternative policies began to be sought. In this context, many developed and developing countries have started using unconventional monetary policy tools to ensure financial stability along with price stability. As a result of the expansionary policies implemented by the central banks of developed countries, there has been an intense capital inflow to Turkey, which has led to credit expansion and overvaluation of the domestic currency. Therefore, as of 2011, the Central Bank of the Republic of Turkey (CBRT) started to use non-traditional monetary policy instruments to support financial stability. In this study, a financial stability index has been calculated for the Turkish economy and the effects of interest rate corridor and required reserve implementations on this index were examined with the Non-Linear Auto Regressive Distributed Lag (NARDL) model. According to the results of the analysis, it has been understood that the effects of unconventional monetary policy tools in ensuring financial stability are limited and monetary policy implementations alone are insufficient.

ECB unconventional monetary policy and SME access to finance

Small- and medium-sized enterprises (SMEs) account for two-thirds of employment in the euro area which makes them a priority for the transmission of monetary policy to the real economy. SMEs in Europe experienced a credit crunch following the sovereign debt crisis. Over the period 2014–2019, the European Central Bank (ECB) engaged in unconventional monetary policy (UMP) to restore funding conditions in the euro area, to support stronger economic growth and higher inflation. We use the ECB/EC Survey on the Access to Finance of Enterprises to examine the relationship between monetary policy and SME access to finance in countries that were most affected by the crisis as follows: Greece, Ireland, Italy, Portugal and Spain. We show that the implementation of UMP increases the probability that firms with higher debt-to-assets ratio remain credit constrained in stressed countries, although this effect becomes insignificant in non-stressed countries. Our findings suggest that monetary policy is transmitted unevenly to leveraged SMEs across jurisdictions. Additionally, we find little evidence that risky firms are credit constrained during periods of UMP, when risk is measured from the firms’ own viewpoint. However, our heterogenous analysis shows that smaller and younger firms—which are also considered to be risky—remain credit constrained over this period. Policy should ensure that UMP trickles down to SMEs regardless of their size, age or location. Tweetable line: Leveraged SMEs in stressed countries are more likely to remain credit constrained even when monetary policy is expansionary. Policy must do more to support small and young firms’ access to credit to facilitate higher investment and growth.

Patterns of unconventional monetary policy spillovers during a systemic crisis

ABSTRACT We examine whether the COVID-19 pandemic-induced systemic shocks cause a change in the dynamics of monetary policy spillovers among developed economies. Results from our analysis under the time-varying parameter vector autoregressive model indicate that: (i) variations in monetary policy actions are explained by monetary policy spillovers; (ii) shocks from the COVID-19 pandemic rocketed monetary policy spillovers; (iii) the Euro area and the US chiefly propagate monetary policy shocks to their counterpart developed economies; and (iv) New Zealand and Japan endure the highest monetary policy shocks. Our results evidence the need for synchronized monetary policy actions during systemic crises.

Spillback effects of US unconventional monetary policy

This study examines the spillback effects of US forward guidance (FG) and large-scale asset purchases (LSAPs) policies based on a proxy structural vector autoregression model and structural scenario analysis. We use high-frequency asset price surprises to identify FG and LSAP shocks. We find that both FG and LSAP shocks have significant spillback effects on economic activity and inflation in the US. Geographically, spillbacks of US unconventional monetary policies materialize more for advanced economies than emerging market economies. In addition, we find that spillbacks materialize through the exchange rate channel, the Tobin’s q channel, and the cash flow channel.

Quantitative Easing and Wealth Inequality: The Asset Price Channel*

AbstractWe assess the impact of the ECB's unconventional monetary policy, specifically of quantitative easing (QE), on the distribution of household wealth in nine euro area countries. For this purpose, we estimate the effects of a QE shock on housing and risky financial asset prices by means of local projections. We then use these estimates to carry out micro‐simulations based on data from the Household Finance and Consumption Survey (HFCS). For the majority of the countries under review, expansionary QE via asset prices leads to net wealth inequality increases when measured using wealth indicators that are sensitive to changes at the tails of the wealth distribution. This finding contrasts with results based on the Gini coefficient which point to an equalizing impact of QE. One‐third of the households in our sample holds neither housing nor financial wealth and is thus not directly affected by QE measures through the asset prices channel.

Macro‐financial effects of monetary policy easing

AbstractThis study examines the impact of Fed monetary policy shocks on financial stress, inflation, and output growth, considering several advanced and emerging economies. To that end, it uses shadow rates as a proxy measure of unconventional monetary policy actions and a financial stress index as an indicator of financial instability. We apply a global vector autoregressive model and present the outcome of impulse response functions and forecasts of macroeconomic and financial stress variables. Our results show that US output and inflation are positively affected in response to a domestic negative monetary policy shock, whereas financial stress is unresponsive to the same shock. This policy also has international effects, as we find significant spillovers with the US interest rate shock impacting inflation abroad. The findings of this study are useful to policymakers and investors.

Co-Movement of Indonesian State-Owned Enterprise Stocks

According to portfolio theory, diversifying investment to several stocks with negative correlations may reduce portfolio risk. In contrast, combining stocks with similar movement (co-movement) has no impact on portfolio risk reduction. This study aims to examine state-owned enterprise stock co-movement in Indonesia using orthogonal generalized auto-regressive conditional heteroscedasticity (O-GARCH) to help investors selectively choose stocks in a portfolio to reduce portfolio risks. Saturation sampling was used since all state-owned enterprise stocks listed on the Indonesian Stock Exchange were selected as samples. Based on monthly data from January 2013 to December 2021, the O-GARCH method was able to simplify the covariance matrix of the 17 SOEs. Of 17 SOEs, 11 had co-movement, as indicated by their similar principal components, whereas the remaining 6 stocks had a different principal component. Hence, investment managers or investors should not put the eleven stocks in the same portfolio as they have similar risk factors; instead, they may combine them with the six remaining SOE stocks which have a different co-movement. In addition, when the fiscal deficit is high and unconventional monetary policy is implemented in a crisis period, the SOE stock co-movement is higher. Thus, the SOE stock co-movement also depends on government-related matters and faces slightly different risks compared to its private-sector counterparts. Hence, the regulators formulating the policy on SOE stock holdings may use the results of this study by considering the potential merging of the SOE stocks with a similar stock return co-movement by taking account the timing in relation to fiscal deficit and crisis period.

Europas Finanzarchitektur im Umbruch

Abstract Since the start of the financial crisis in 2008, European economies have been hit by unprecedented exogenous shocks. The ECB has countered these with unconventional monetary policy, extraordinary high new fiscal borrowing and a permanent Stability Mechanism (ESM). On top of all that, in response to the coronavirus crisis, European Community Bonds have been issued for the first time. All of these new measures have proved helpful, but equally contradictory to the rules of the single currency as laid down in the Maastricht Treaty. The intertwining of monetary and fiscal policies is currently proving to be a precondition for the cohesion of the common currency. This makes it indispensable in the design of a resilient and credible new financial architecture for Europe.

Housing, the credit market, and unconventional monetary policies: from the sovereign crisis to the great lockdown

Abstract This article evaluates the interactions between housing, the credit market, and the ECB’s asset purchase program (APP) from 2015 until 2020 and then in the course of the ECB’s pandemic emergency purchase program (PEPP) in 2020. The model is calibrated for the euro area. The findings illustrate the way in which macrohousing channels affect bank portfolio rebalancing which is the main channel for asset purchases to influence the economy. The results show that asset purchasing performs better during a crisis, particularly if it is conducted for an appropriate extent of time. The findings suggest that the PEPP alone is not sufficient to accelerate recovery. As a result, further actions such as timely targeted fiscal policies are required to step up recovery. However, to protect the financial sector, the PEPP should be extended until the Covid-19 crisis phase is over.

What Is the European Central Bank Supposed to Do?

Abstract In July 2021, the European Central Bank (ECB) published a new monetary policy strategy, the first time in 17 years that it had undertaken a review of its monetary policy. In the intervening time, the world – and the economic challenges facing the ECB – have changed immensely but partly as a result of the ECB’s own maneuvering. In particular, monetary policy has been relied upon for every single malaise facing the global economy, including and up to the coronavirus pandemic. This paper argues that a review of central banks as an institutional mechanism in general, and in particular the ECB, was overdue but should not have been limited to policies; instead, an opportunity was missed to have an institutional review to examine whether or not it has been performing as intended. In particular, the vast experiment of unconventional monetary policy/issuance should have been more scrutinized from an institutional level as it appears to have contributed to the current problems the European economy faces. Europe and the ECB would be well served by taking stock of its actions over the past two decades and especially during the era of unconventional monetary policy to find a sustainable route forward.

Identification with External Instruments in Structural VARs

IV methods have become the leading approach to identify the effects of macroeconomic shocks. Conditions for identification generally involve all the shocks in the VAR even when only a subset of them is of interest. This paper provides more general conditions that only involve the shocks of interest and the properties of the instrument of choice. We introduce a heuristic and a formal test to guide the specification of the empirical models, and provide formulas for the bias when the conditions are violated. We apply our results to the study of the transmission of conventional and unconventional monetary policy shocks.

The effects of conventional and unconventional monetary policy on the unemployment rate in the US

PurposeThe purpose of this paper is to investigate the impact of the Federal Reserve's conventional and unconventional monetary policy shocks on the US unemployment rate.Design/methodology/approachThe authors employ a unified time-varying framework to an extensive data set from 1960 to 2019.FindingsThe authors find that both conventional and unconventional monetary policy influence the unemployment rate, but the effects of unconventional monetary policy vary greatly during the first, second and third rounds of quantitative easing (dubbed QE1, QE2 and QE3, respectively). It significantly influenced the unemployment rate in QE3. However, the effects are less persistent than the effects of conventional monetary policy shocks. The impact of unconventional monetary policy transmits to the real economy through conventional interest rates, exchange rates and asset price channels. The responses of unemployment rate are smaller during QE1 and QE2 due to the rise in inflation uncertainty and economic policy uncertainty.Originality/valueThe impact of the Fed's unconventional monetary policy shocks on the US unemployment rate during QE1, QE2 and QE3 is time-varying. It is explained by inflation uncertainty and real option channels.

Testing the Effectiveness of Unconventional Monetary Policy in Japan and the United States

The effective lower bound (ELB) on a short term interest rate may not constrain a central bank's capacity to achieve its objectives if unconventional monetary policy (UMP) is powerful enough. We formalize this 'irrelevance hypothesis' using a dynamic stochastic general equilibrium model with UMP and test it empirically for the United States and Japan using a structural vector autoregressive model that includes variables subject to occasionally binding constraints. The hypothesis is strongly rejected for both countries. However, a comparison of the impulse responses to a monetary policy shock across regimes shows that UMP has had strong delayed effects in each country.