Can we declare unconventional monetary policy a victory?
(full article here)
Central banks resort to quantitative easing when the normal monetary policy tool of lowering the short-term interest rate is constrained. This constraint typically arises from the zero-lower bound, i.e. the inability to lower nominal rates below zero. This can result in a real interest rate that, while negative, is still too high for an economy to quickly find back to full employment and equilibrium. Many indicators such as the low inflation rate, the high unemployment rates, the current account surplus and the excess savings compared to the weak investment suggest that the euro area is in such a situation.
Quantitative easing attempts to address this situation by lowering long-term interest rates – improving investment conditions and dis-incentivising savings – (interest rate channel), purchasing relatively safe long-term assets thereby driving investors into riskier investments (portfolio re-balancing channel), and weakening the exchange rate (exchange rate channel).
The main criticism of the ECB’s sovereign QE programme are that it is (i) unlawful in a monetary union without a joint treasury, (ii) ineffective and or unnecessary, (iii) associated with negative side effects in terms of financial stability and inequality. The first criticism has abated also thanks to the design of the programme. This briefing focuses on the second and third criticism.
We argue that the ECB’s QE programme is indeed necessary given the general macroeconomic situation and the continuing weak inflation dynamics. But the continuously weak inflation dynamics have raised doubts on its effectiveness.
Assessing the effectiveness of QE is difficult as one has to define a counter-factual. This cannot be achieved in this briefing paper but we show that QE had a strong effect on the exchange rate channel, weakening the euro-dollar exchange rate substantially. We also show that long-term interest rates fell substantially in anticipation of the programme. As regards portfolio-rebalancing, we show that banks have not shed sovereign debt from their balance sheets at a significant scale so the purchases have been from different actors. We show that investment has slightly picked up, housing markets in some countries have gained strength but credit creation is only slightly increasing. Finally, we show that the increase in the sovereign QE on XX has had no visible effect on any variable.
As regards financial stability, we document that QE has reduced the profitability of banks by narrowing their margins. The recent corporate QE, while lowering corporate yields, is further reducing margins for banks.
Going forward, we argue that further monetary policy action is unlikely to carry strong benefits. One sensible avenue for monetary policy could be to enact the sovereign bond purchases from banks so as to reduce the exposure of banks to sovereign debt. More important, however, is government action. In particular, progress with dealing with the debt overhang, banking fragilities, and fiscal measures in countries with fiscal space would help speed the recovery and increase inflation rates.
