How Fed asset purchases reduce yield term premia

February 15, 2014

An updated Federal Reserve paper suggests that there has long been a link between the net supply of government securities and term premia on Treasury yields. A 1%-point reduction in the ratio of Treasuries or MBS (10-year equivalent) to GDP supposedly reduced the 10-year term premium by 10 basis points. A one-year shortening of the average effective duration would lower the ten-year Treasury yield by about 7 basis points. Based on these estimates, the 2008-2011 large scale asset purchase and maturity extension programs of the Federal Reserve could have reduced the 10-year term premium by a total of 150 basis points.

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Central banks and equity market distress

December 17, 2013

A short Bundesbank paper presents evidence that the Federal Reserve, the ECB, and the Bank of England have long used policy rates to stabilize financial markets in times of distress. This would suggest that implicit ‘central bank puts’ are not new and that central banks’ tendency to stabilize markets in the past has not prevented serious market dislocations.

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The importance of central bank collateral frameworks

December 11, 2013

A new ECB paper illustrates the power of a central bank’s collateral framework as a policy tool. The collateral framework influences overall monetary conditions, helps preserving financial stability, and functions even at the zero lower bound for policy rates. Liquidity regulation can be an important complement, since by themselves generous collateral buffers might invite moral hazard and encourage excessive reliance on short-term funding.

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The ultimate policy options of the European Central Bank

December 7, 2013

In case of further negative shocks the ECB has three final policy options. First, it could nudge its refinancing rate close to zero and become the first large central bank to introduce a negative deposit rate. Second, it could revive long-term repo operations, probably with a link to private credit and collateral enhancement, and accompanying cuts in minimum reserves and sterilization operations. Third, as a final recourse, the ECB could invoke its right to buy both public and private securities for the purpose of preserving price stability. This final step would raise most difficult operational issues, far more so than quantitative easing in other currency areas.

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A review of Fed forward guidance and maturity extension

December 3, 2013

The Federal Reserve’s forward guidance and maturity extension policies demonstrated how non-conventional monetary policy operates through both “signaling effects” and “portfolio effects” Forward guidance reduced yields beyond the guidance period. It was treated by markets as a broader commitment to lasting accommodation, underscoring the power of signaling. The Maturity Extension Program, by contrast, raised shorter-dated rates, even within the forward guidance window, illustrating the general importance of the “portfolio effect”.

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A brief history of monetary policy and asset price booms

November 20, 2013

A new NBER paper reminds us of historical episodes when loose monetary policy contributed to asset price booms and busts. The paper also provides econometric evidence that low policy rates usually support asset prices. This history may not dissuade central banks from running highly accommodative policies at present, but explains the importance of accompanying macro-prudential measures.

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Understanding the U.S. monetary policy framework

November 10, 2013

A new staff paper summarizes the Federal Reserve’s policy framework, as it evolved in the face of the zero lower bound for interest rates. The framework is predicated on the principles of excess stimulus, history dependence, economic conditionality, and credible communication. Its main tools are interest rate forward guidance and asset purchases. A higher inflation target or a nominal income level target is under discussion. The integration of monetary and macro-prudential policies has progressed.

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How easy G3 monetary policy spills over into East Asia

November 2, 2013

A recent BIS paper illustrates the consequences of highly accommodative monetary policy in the G3 for East Asia. These include lower policy rates than warranted by domestic conditions, lower bond yields and appreciation pressure on currencies. Importantly, easy G3 monetary conditions stimulate Asian foreign currency borrowing in many forms, including letters of credit, forward selling of foreign currencies and international bond issuance.

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Liquidity regulation and monetary policy

October 24, 2013

From 2015 banks will have to satisfy new liquidity standards. Of particular importance is the liquidity coverage ratio, which requires institutions to hold enough “high quality liquid assets” to withstand a 30-day period of funding stress. This will complicate the conduct of monetary policy and affect short-term yield curves, which will probably price some regulatory term premium.

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A theory of safe asset shortage

October 21, 2013

Ricardo Caballero and Emmanuel Farhi from MIT and Harvard propose an interesting and relevant formal model of safe asset shortage. While safe asset supply is constrained by the fiscal capacity of sovereigns and financial innovation, demand may be in a secular ascent (driven for example by collateralization and population aging). The resulting shortfall can result in a structural drag on economic growth and impair the effectiveness of fiscal and monetary policies, with some resemblance to the Keynesian liquidity trap.

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