Unconventional Monetary Policies

 

 

What alternative monetary policy tools at the zero lower bound?

 

Mario Draghi sums up the secular stagnation paradigm in which Euro Area economies are stuck into as a disanchoring of inflation expectations. In order to shield economies from downward pressures on investments, confidence and ultimately long-term growth, the European Central Banker announced for the first time a two-fold package comprising quantitative and credit easing on November, 21st, 2014. "The Governing Council has communicated its expectation that the combination of all the monetary policy measures it has decided on will expand the Eurosystem’s balance sheet towards the levels prevailing in early 2012. The addition of purchases of covered bonds to ABS purchases will allow us to conduct interventions on a scale that will achieve the intended effects in terms of portfolio rebalancing and signalling". Read more...

 

More to read on this issue :

 

• N. Roubini, Project Syndicate, "An Unconventional Truth", Feb 2015. Read more...

 

Effectiveness of QE

 

Joyce and al. (2015) provide new evidence on the effectiveness of QE through the portfolio balance channel. The latter refers to the mechanism according to which Central Banks' large asset purchases modify private sector's expectations about future interest rates thereby pushing up asset prices and reducing long-term yields. Using a counterfactual analysis of investment behaviour, Joyce and al. demonstrate there has been a portfolio reallocation on the part of pension funds and insurance companies in the UK in the aftermath of the 2009 QE programme.

 

What should one expect from the current QE program launched by the ECB in March, 2015? Some economists suggest QE is not only ineffective but counterproductive: it reinforces the spiral of private and public debt. In the US, corporate benefits are driven by share buyback and other financial leveraging actions, taking advantage of low interest rates. But further indebtedness does not fuel into real economy because of low perspectives of demand. The net creation of 300, 000 jobs in February, 2015 misleadingly masks a very low participation rate that might fringe upon further consolidated aggregate demand. Similarly, in the euro zone, the current QE program may inflate public deficits and throw European economies back into an unsustainable debt panic stemming from financial markets. Other economists argue on the contrary low bond yields change the deal and incentivise euro zone governments to engage into Keynesian public investments plans to compensate for the lack of private demand.

 

Many economists call for a bolder intervention than QE on the part of central banks, such as helicopter money. Muellbauer suggests a "QE for the people" consisting in distributing a €500 cheque to every euro-area adult citizen. Similarly, Reichlin and al. (2014) support overt monetary financing of government deficits that is deemed to be the most efficient and less costly way to raise both demand and output (Bossone and al., 2014).

 

 

More to read on this issue :

 

• M. Feldstein, Project Syndicate, "The Eurozone Needs More than QE",  (Jan 2015). Read more...

 

Is it too late for the Eurozone ?

 

Orphanides (2014) wonders why the ECB has implemented such a restrictive monetary policy since 2012 compared to the FED. Whether this hardline stance reflects political pressures or ideological beliefs, what matters now for the ECB is to commit to a full-blown QE with government bond purchases.

 

More recently, Huttl and Merler (Bruegel) highlight both the scope and impact of LTRO are minimal and far from fulfilling the ECB's expectations.

 

More to read on this issue :

 

Mr.Constancio, vice-president of the ECB announced on November 26th, 2014 : "We will have to consider buying other assets, including sovereign bonds in the secondary market, the bulkier and more liquid market of securities available.” Read more...

 

Exiting UMPs: will it hurt?

 

Normalisation of FED's monetary policy is expected to occur in the midyear though several indicators might postpone Yellen's decision to raise interest rates. Amongst these indicators lies the 5y5y foward inflation which is a market-based breakeven that regained popularity since Mario Draghi's Jackson Hole speech in 2014. As suggested by Jeremy Cohen-Setton, the FED and the ECB interpret differently the decline in inflation compensation, the latter being more alarming on potential inflation disenchoring than the former. What could really trigger FED's strides towards normalisation is the situation on the labor market. As higlighted in an article of the WSJ: "Janet Yellen has placed labor market developments and the reduction of labor market slack at the center of the FED's reaction function". Strong gains in hiring and substantial net job creations augur well for reflationary pressures in the medium-term in the US. On the contrary, such a trend is not to be seen soon enough in the eurozone, hence the ECB's launch of a full blown QE program. The diverging trends in both sides of the Atlantic might suggest further monetary decoupling therefore consequences on exchange rates' variations and competitiveness concerns.

 

More to read on this issue :

 

• Economit's View, December 22nd, 2014, by Tim Duy: Asked and Answered. Mostly.