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«Monetary and Economic Department July 2016 JEL classification: E40, E50, E52, E58, E60. Keywords: unconventional monetary policies, balance sheet ...»

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BIS Working Papers

No 570


monetary policies:

a re-appraisal

by Claudio Borio and Anna Zabai

Monetary and Economic Department

July 2016

JEL classification: E40, E50, E52, E58, E60.

Keywords: unconventional monetary policies, balance

sheet policies, forward guidance, negative interest


BIS Working Papers are written by members of the Monetary and Economic

Department of the Bank for International Settlements, and from time to time by other economists, and are published by the Bank. The papers are on subjects of topical interest and are technical in character. The views expressed in them are those of their authors and not necessarily the views of the BIS.

This publication is available on the BIS website (www.bis.org).

© Bank for International Settlements 2016. All rights reserved. Brief excerpts may be reproduced or translated provided the source is stated.

ISSN 1020-0959 (print) ISSN 1682-7678 (online) Unconventional monetary policies: a re-appraisal Claudio Borio and Anna Zabai# Abstract We explore the effectiveness and balance of benefits and costs of so-called “unconventional” monetary policy measures extensively implemented in the wake of the financial crisis: balance sheet policies (commonly termed “quantitative easing”), forward guidance and negative policy rates. Our objective is to provide the reader with a helpful entry point to the burgeoning empirical literature and with a specific perspective on the complex issues involved. We reach three main conclusions: there is ample evidence that, to varying degrees, these measures have succeeded in influencing financial conditions even though their ultimate impact on output and inflation is harder to pin down; the balance of the benefits and costs is likely to deteriorate over time; and the measures are generally best regarded as exceptional, for use in very specific circumstances. Whether this will turn out to be the case, however, is doubtful at best and depends on more fundamental features of monetary policy frameworks. In the paper, we also provide a critique of prevailing analyses of “helicopter money” and explore in more depth the role of negative nominal interest rates in our fundamentally monetary economies, highlighting some risks.

Keywords: unconventional monetary policies, balance sheet policies, forward guidance, negative interest rates.

JEL classification: E40, E50, E52, E58, E60.

Bank for International Settlements.

# This paper was prepared for R Lastra and P Conti-Brown (eds), Research Handbook on Central Banking, Edward Elgar Publishing Ltd. We thank Piti Disyatat, Dietrich Domanski and Hyun Shin for comments and suggestions. Jeff Slee and Anamaria Illes provided excellent statistical assistance. The views expressed in this paper are those of the authors and do not necessarily reflect those of the BIS.

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I. A taxonomy and a few facts


What central banks have done

II. Influence on financial conditions: what do we know?

Balance sheet policies

Forward guidance

Negative policy rates

III. Influence on the macro-economy and broader considerations

Formal empirical evidence on output and inflation

The importance of context and measure-specific characteristics

Box 1: Delving into negative interest rates and “money illusion”

Box 2: Understanding “helicopter money”

The political economy



–  –  –

They were supposed to be exceptional and temporary – hence the term “unconventional”. They risk becoming standard and permanent, as the boundaries of the unconventional are stretched day after day.

Following the Great Financial Crisis, central banks in the major economies have adopted a whole range of new measures to influence monetary and financial conditions. The measures have gone far beyond the pre-crisis typical mode of operation – controlling a short-term policy rate and moving it within a positive range.

To be sure, some of these measures had already been pioneered by the Bank of Japan roughly a decade earlier in the wake of that country’s banking crisis and stubbornly low inflation. But no one had anticipated that they would spread to the rest of the world so quickly and would become so daring.

How effective have these measures been? What broader issues do they raise?

These are the two main questions we address in this essay. We do not intend to be comprehensive or provide a definitive analysis – the issues are far too complex and controversial. Rather, our objective is simply to take our cue from the burgeoning literature to provide some reflections on the subject. This should help the reader gain easier access to the rapidly growing body of work and approach it with one more perspective in mind.

What is “conventional” or not is partly in the eye of the beholder. To define our coverage, we take as benchmark pre-crisis implementation frameworks. On that basis, we discuss: (i) using the central bank’s balance sheet to influence financial conditions beyond the short-term rate – “balance sheet policies” (Borio and Disyatat (2010)); (ii) actively managing expectations of the future path of the policy rate to provide extra stimulus when rates have reached their (perceived) lower bound – (interest rate) “forward guidance”; and (iii) setting policy rates below zero in nominal terms – “negative interest rate policy “ (NIRP). We thus exclude from the analysis foreign exchange intervention although, analytically, it is a subset of balance sheet policies (Borio and Disyatat (2010)).1 In addition, we limit our discussion to four central banks – the Federal Reserve, the European Central Bank (ECB), the Bank of Japan and the Bank of England – except when we address NIRP, in which case we briefly touch on the experience of the Swiss National Bank (SNB), Danmarks Nationalbank and the Swedish Riksbank.

We highlight three conclusions.

First, there is ample evidence that, to varying degrees, these measures have succeeded in influencing financial conditions. There is little doubt that they have had a lasting impact on bond yields, various asset prices and exchange rates. Their relative effectiveness, however, is still subject to debate, as it is sometimes difficult to disentangle their impact (eg that of forward guidance from that of large-scale asset purchases). The same conclusion holds for their ultimate impact on output and inflation. Here, the empirical evidence is thinner and the researcher faces tougher What is specific about foreign exchange intervention is (i) the asset purchased – denominated in foreign rather than domestic currency – and, hence (ii) the aspect of financial conditions targeted – the exchange rate rather than a set of domestic asset prices. But foreign exchange intervention was already a standard policy tool pre-crisis around the world. At the same time, we do discuss briefly the use of foreign exchange swap lines, used to address funding conditions in foreign currency.

WP570 Unconventional monetary policies: a re-appraisal 1 challenges. These include difficulties in developing the correct metrics and in filtering out the influence of other factors on output and inflation (eg so-called “headwinds”) as well as the need to rely more heavily on modelling assumptions.

Second, formal econometric evidence on whether such policies are subject to diminishing returns is limited, partly owing to methodological complications. Views, therefore, differ. Our own assessment is that this is likely to be the case. There are bound to be limits to how far nominal interest rates can be reduced and risk spreads compressed. And there may be discontinuities and tipping points in the behaviour of financial intermediaries and economic agents more generally. Examples include the impact on the profitability and resilience of financial intermediaries and on the public’s confidence.

Finally, there are broader questions about the long-term effectiveness and desirability of these measures. Some have to do with the measures’ overall impact on the central bank goals; others with political economy considerations, which may ultimately undermine the central bank’s perceived legitimacy and autonomy (or “independence”). Exit issues loom large. Our view is that many of these measures should be best regarded as exceptional and for use in very specific circumstances, rather than be considered normal tools for normal conditions. Whether this will turn out to be the case, however, is doubtful at best and depends on more fundamental features of monetary policy frameworks.

The rest of the essay is organised as follows. Section I presents a taxonomy of central bank measures along the lines of Borio and Disyatat (2010) and then sketches what central banks have done. Section II briefly summarises and evaluates the evidence on the effectiveness of the various measures in influencing financial conditions. Section III examines their impact on output and inflation and addresses broader considerations, including the issues raised by exit and political economy considerations. The conclusions highlight key policy challenges in the years ahead.

One box provides a critique of prevailing analyses of “helicopter money”; the other discusses in more depth the role of negative nominal interest rates in our fundamentally monetary economies, highlighting some risks.

I. A taxonomy and a few facts Taxonomy Monetary policy is implemented in two ways (Table 1). One is through interest rate policy, whereby the central bank influences financial conditions by setting, or closely controlling, a short-term rate (often overnight) and by steering expectations about where it will be set in future (“interest rate forward guidance”). The other is through balance sheet policy, whereby the central bank influences financial conditions beyond the short-term rate by adjusting its balance sheet (size and/or composition). Typical examples of balance sheet policy include large-scale asset purchases and the supply of central bank funding (“liquidity”) at non-standard terms and conditions (eg at long maturities, for specific lending purposes). Just as in the case of interest rate policy, the central bank may also wish to steer expectations about future balance sheet adjustments (“balance sheet forward guidance”).

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https://www.ecb.europa.eu/press/pressconf/2013/html/is130704.en.html. 3 Bank of Japan, ibid. 4 Starting on 5 June 2014, https://www.ecb.europa.eu/press/pr/date/2014/html/pr140605_3.en.html. 5 Starting on 29 January 2016, http://www.boj.or.jp/en/announcements/release_2016/k160129a.pdf.

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40 3,000 20 3,000 30 2,000 15 2,000 20 1,000 10 1,000

–  –  –

25 400 90 4,000 20 300 70 3,000 50 2,000

–  –  –

Securities held outright. Includes securities lent to dealers under the overnight securities lending facility. 2 Repurchase agreements, term auction credit, other loans and Commercial Paper Funding Facility. Repurchase agreements are the cash value of agreements, which are collateralised by US Treasury and federal agency securities. 3 Securities of euro area residents and general government debt, in euros. 4 Lending to euro area credit institutions related to monetary policy operations, in euros. 5 Including US dollar liquidity auctions.

For the euro system this includes all foreign currency claims to both residents and non-residents of the euro area. 6 The Bank of England changed the balance sheet methodology starting 24 Sept 2014, which might result in breaks in the data and changes in the definitions. 7 Bonds and other securities acquired via market transactions up to 24 Sept 2014 and longer-term sterling reverse repos and sterling-denominated bond holdings thereafter. 8 Fine-tuning and one-week short-term open market operations and indexed long-term repos. 9 Including US dollar liquidity auctions and loans to the Bank of England Asset Purchase Facility Fund up to 24 Sept 2014 and foreign currency reserve assets and loans to the Bank of England Asset Purchase Facility Fund thereafter. 10 Defined as Japanese government bonds and corporate bonds. 11 Loans excluding those to the Deposit Insurance Corporation. Includes resale agreements.

Sources: Datastream; national data.

In the case of quasi-debt management policy, central bank operations target the market for public sector debt by altering the composition of such claims held by the private sector. These claims include securities of different maturity as well as bank reserves held with the central bank. The main intention is to alter the yield on government securities, thereby influencing the cost of funding and asset prices more generally. For example, the central bank may buy long-term government bonds and sell shorter-term bonds; or it may finance the purchase of those bonds by issuing its

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34 2,400 18 3,000 26 1,600 12 2,000 6 1,000

–  –  –

25 400 90 4,000 70 3,000 50 2,000 30 1,000

–  –  –

Reserve balances with Federal Reserve System Banks. 2 Total includes equity (net assets). 3 Banknotes in circulation. 4 Current accounts, covering the minimum reserve system. 5 The Bank of England changed the balance sheet methodology starting 24 Sept 2014, which might result in breaks in the data and changes in the definitions. 6 Including to central banks. 7 Payables under repurchase agreements. 8 Current deposits; excludes government deposits, and deposits held by foreign central banks and others.

Sources: Datastream; national data.

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