Unconventional Monetary Policy in Theory
and Practice
Giuseppe Ferrero
Banca d’Italia
NBRM Conference 26 April 2013 - Skopje
NATIONAL BANK OF THE REPUBLIC OF MACEDONIA
Conference on
"Policy Nexus and the Global Environment:
A New Consensus Emerging from the Crisis?"
26 April, 2013, Skopje
The opinions expressed in this presentation do not necessarily reflect those of the Bank of Italy
Unconventional Monetary Policy in Practice
Institutional Framework (Eurosystem vs Federal Reserve)
The “decoupling” principle (Official interest rates vs base money)
Unconventional Monetary Policy in Theory
The transmission mechanism (Normal vs crisis times)
A classification (QE, CE, Forward guidance)
The main channels (Signaling & Portfolio-balance channels)
The Effectiveness of Unconventional Monetary Policy
Announcement vs actions (SMP)
Risk free vs premia component (QE vs SMP)
Discretion vs commitment (SMP vs OMT)
Back to Conventional Monetary Policy
Credibility, commitment, transparency, independence
Outline of the Presentation
Unconventional Monetary Policy in Theory and Practice – Giuseppe Ferrero
The Institutional Framework (pre crisis)
Eurosystem Fed
Objective Price stability (*) (i) Maximum employment
(ii) Price stability
Decisions
(i) ML rate
(ii) Minimum rate
(iii) Dep. Fac. rate
Fed fund rate
Strategy
“Two Pillars”:
(i) Economic analysis
(ii) Monetary analysis
Economic analysis
Operational
Framework
(i) OMO (REPOs)
(ii) Standing Facilities
(ML, dep. fac,.)
(iii) Reserve Requirement
(i) OMO (outright purchases)
(ii) Standing Facilities
(discount window)
(iii) Reserve Requirement
Main
counterparties Credit institutions Primary dealers
Unconventional Monetary Policy in Theory and Practice – Giuseppe Ferrero
Eurosystem balance sheet: Assets
(€ blns)
0
200
400
600
800
1000
1200
Jun-2007
Gold stock
Securities
Other assets
REPO
Fed balance sheet: Assets
($ blns)
0
200
400
600
800
1000
1200
Jun-2007
Gold stock
Securities
Other assets
LTRO
MRO
The Operational Framework: Balance Sheet
Unconventional Monetary Policy in Theory and Practice – Giuseppe Ferrero
Decoupling principle. “The same amount of bank reserves
can coexist with very different levels of interest rates;
conversely, the same interest rate can coexist with different
amounts of reserves”. (Borio & Disyatat, 2010)
The central bank can set the overnight rate at whatever level it
wishes by signaling the level of the interest rate it would like
to see. Signaling acts as a coordinating device for market
expectations.
The Decoupling Principle
Unconventional Monetary Policy in Theory and Practice – Giuseppe Ferrero
Conventional MP and Decoupling Principle
MRO rate and Base Money (Euro Area)
1.5
2
2.5
3
3.5
4
4.5
Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08
0
200
400
600
800
1000
1200
MRO rate (L-H scale) Base money (R-H scale)
Unconventional Monetary Policy in Theory and Practice – Giuseppe Ferrero
MRO rate and Base Money (Euro Area)
Unconventional MP and Decoupling Principle
0
0.5
1
1.5
2
2.5
3
Jan-09 Jan-10 Jan-11 Jan-12 Jan-13
800
1000
1200
1400
1600
1800
2000
MRO rate (L-H scale) Base money (R-H scale)
Unconventional Monetary Policy in Theory and Practice – Giuseppe Ferrero
Transmission Mechanism in Normal Times
Unconventional Monetary Policy in Theory and Practice – Giuseppe Ferrero
Transmission Mechanism during a Financial Crisis
(i) volatility of demand for reserves
and (ii) limited redistribution of
reserves among depository institutions,
affect central bank’s ability to control
short-term interest rates in the
interbank market.
disruptions in other segments of
the financial market may
hamper the transmission of the
monetary impulse across the full
spectrum of financial assets.
When the effect of the crisis on the
real economy is large, the zero lower
bound for interest rates may
become a binding constraint for
monetary policy decisions.
Unconventional Monetary Policy in Theory and Practice – Giuseppe Ferrero
A classification scheme
Credit easing: provide liquidity to disfunctional markets.
Quantitative easing: purchases of long-term bonds to
reduce the slope of the yield curve.
Forward guidance: provide information about future
macroeconomic variables.
Unconventional Monetary Policy
Two channels:
The signaling channel: communication.
The portfolio-balance channel: purchase of securities
and provision of credit.
Unconventional Monetary Policy in Theory and Practice – Giuseppe Ferrero
The Signaling Channel in practice
The efficacy of this channel relies on
the credibility of the central bank
the extent to which private expectations affect
macroeconomic and financial market conditions.
Central bank’s communications (or actions) informing the
public about its intentions regarding
the future evolution of short-term interest rates,
the purchase of financial assets,
the implementation of other measures targeted at
counteracting market dysfunctions.
“Time inconsistency” may severely limit the effectiveness of the
announcement of an interest rate path.
Unconventional Monetary Policy in Theory and Practice – Giuseppe Ferrero
Krugman (1998): “irresponsibility principle”. To escape the
ZLB, the central bank should convince the market that it will
allow prices to raise so to increase inflationary expectations.
Eggertsson and Woodford (2003) conclude that the signaling
channel “is the only channel that is effective”.
Clarida (2010) argues that this type of communication, if not
properly qualified, “may in practice be confused by the public
with a policy of discretion” and therefore be ineffective.
Woodford (2012) argues that to be effective the communications
should be in the form of a “commitment to a target criterion as
the basis for future policy deliberation”.
The Signaling Channel in theory
Unconventional Monetary Policy in Theory and Practice – Giuseppe Ferrero
The portfolio-balance channel is activated through central bank
operations such as
outright purchases of securities,
asset swaps and
liquidity injections,
which modify the size and the composition of the balance sheet
of both the central bank and the private sector.
The Portfolio-balance channel in practice
Operates through imperfect substitutability on the asset side of
the private sector balance sheet: the net relative amount of
securities in the market is a determinant of their relative
yields.
Unconventional Monetary Policy in Theory and Practice – Giuseppe Ferrero
Agents are heterogeneous due to:
preferences for long-term securities (Vayanos and Vila, 2009)
borrowing constrained (Gertler and Karadi, 2010)
different degrees of risk-aversion (Ashcraftet al 2010)
different impatience to consume (Curdia and Woodford 2010)
information asymmetries or limited commitment (Cúrdia and
Woodford (2011), Demirel (2009), Gertler and Karadi (2011),
Gertler and Kiyotaki (2010).
Items on the liability side of the private sector balance sheet are
imperfect substitutes and open market operations have
distributional effects with potential effects on real activity and
inflation.
The Portfolio-balance channel in theory
Unconventional Monetary Policy in Theory and Practice – Giuseppe Ferrero
Portfolio-balance channel in practice: Eurosystem
55%
43%8%
10%
9%
38%
37%
0
500
1000
1500
2000
2500
3000
3500
Jun-2007 Jan-2013
Loans to depository
institutions
Securities held for monetary
policy purposes
Other securities
Other assets
1186 bln
2956 bln
+ 1.8 trn
68%
7%
1%
32%
2%
89%
0
200
400
600
800
1000
1200
Jun-2007 Jan-2013
LTRO 36m
LTRO 3m
LTRO 1m
MRO
Eurosystem balance sheet: Assets (€ blns)
Unconventional Monetary Policy in Theory and Practice – Giuseppe Ferrero
Portfolio-balance channel in practice: Federal Reserve
Federal Reserve balance sheet: Assets ($ blns)
0
500
1000
1500
2000
2500
3000
3500
Jun-2007 Jan-2013
Securities held outright
>10 year
>5 year and <10 year
>1 year and <5 year
<1 year
10%
10%
88%
90%
2%
0
500
1000
1500
2000
2500
3000
3500
Jun-2007 Jan-2013
Other assets
REPOs & Loans to depository
institutions
Securities held outright
902 bln
2972 bln
+ 2.1 trn
Unconventional Monetary Policy in Theory and Practice – Giuseppe Ferrero
In May 2010 the ECB decides to implement a program of
purchase of Euro area private and public securities (Securities
Markets Programme (SMP):
Objective: support an appropriate functioning of the
monetary transmission mechanism;
Dimension: temporary and its amount limited;
Effects on the monetary base: neutralized through liquidity-
absorbing operations.
In August 2011 the ECB reactivates the program.
Effectiveness: Announcement vs Actions
Unconventional Monetary Policy in Theory and Practice – Giuseppe Ferrero
-5
0
5
10
15
20
25
Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sept
2010 2011 2012
-50
0
50
100
150
200
250
SMP net purchases SMP stock (rhs)
SMP purchases (€ blns)
Effectiveness: Announcement vs Actions
Unconventional Monetary Policy in Theory and Practice – Giuseppe Ferrero
0
0.1
0.2
0.3
0.4
0.5
0.6
Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11
Figure - Impact on volatility on 10-year Italian Government bond
(Intraday max-min yields; % points)
Effectiveness: Announcement vs Actions
Announcement (signaling channel): large impact on Italian
government bonds yields: about -100 bp (on all maturities)
Unconventional Monetary Policy in Theory and Practice – Giuseppe Ferrero
Effectiveness: Announcement vs Actions
Actions (portfolio-balance channel): very large impact on Italian
government bonds yields: estimated effect of about 180 bp.
No published works …
… however, the ECB Research Bulletin (winter 2012) cites
a work of Eser and Schwaab (2012) on SMP interventions:
for large countries like Italy, the estimated effect of €1 bln
purchases = -2 bp on bond yield …
…moreover, on February 2013 the ECB decides to publish
the Eurosystem’s holdings of securities by country acquired
under the SMP: 103 bln of Italian government bonds ...
… an estimated effect of about 180 basis points (in line
with our internal estimates).
Unconventional Monetary Policy in Theory and Practice – Giuseppe Ferrero
Quantitative Easing (QE) in US
Announcement : impact on 10-year Treasury yields of QE1 =
-100 bp; QE2 = -30 bp (Kryshnamurthy et al 2011).
Purchases: estimated impact on long-term Treasury yields of
$400bn purchases = around -70 bp (D’amico and King 2010)
Large asset purchases in SMP had larger effects than in QE
programs.
Unconventional monetary policy measures are more effective
when targeted to address a specific market failure.
In the US, additional monetary stimulus.
In the Euro area, impairments in the transmission process.
In the US, mostly effects on risk-free component.
In the Euro area, effects on risk premia.
Effectiveness: Risk free vs risk component
Unconventional Monetary Policy in Theory and Practice – Giuseppe Ferrero
In September 2012 the ECB decides on the modalities for
undertaking Outright Monetary Transactions (OMTs).
Similarities with the SMP are:
Objective: support an appropriate functioning of the
monetary transmission mechanism;
Effects on the monetary base: neutralized through liquidity-
absorbing operations.
Main differences with SMP are
strict and effective conditionality;
No ex-ante quantitative limits on their size and duration;
pari passu treatment of the Eurosystem as private creditors;
transparency on the main characteristics of the operations.
Effectiveness: Discretion vs Commitment
Unconventional Monetary Policy in Theory and Practice – Giuseppe Ferrero
-250
-200
-150
-100
-50
0
2-year 3-year 5-year 10-year
-250
-200
-150
-100
-50
0
OMT announcement SMP announcement
Figure - Impact on Italian Government bonds (basis points)
2-year 3-year 5-year 10-year
SMP Governing Council
(8-8-2011) -103 -100 -107 -90.8
Draghi’s London speach
(26-7-2012) -116 -101 -77 -49
Governino Council
(2-8-2012) -64 -50 -27 12
Governino Council
(6-9-2012) -21 -30 -42 -46
OMT
Cumulated -201 -180 -146 -83
Effectiveness: Discretion vs Commitmen
Unconventional Monetary Policy in Theory and Practice – Giuseppe Ferrero
Conclusions
Heterogeneity of Unconventional Monetary Policies across time and
across Countries depends on
(Conventional) institutional framework and
which aspect of the monetary policy framework is involved (stance
vs transmission mechanism).
Effectiveness: back to Conventional Monetary Policy
Before the crisis, the literature identified 4 crucial elements for
(conventional) monetary policy to be effective: credibility,
commitment, transparency, independence …
… the evidence on unconventional monetary policy seems to
suggest that at least 3 out of 4 are also crucial for effectiveness of
unconventional monetary policies.
Unconventional Monetary Policy in Theory and Practice – Giuseppe Ferrero
The End