Unconventional Monetary Policy in Advanced Economies Vladimir Klyuev Research Department International Monetary Fund The views expressed herein are those of the author and should not be attributed to the IMF, its Executive Board, or its management.

2 Outline Reasons for unconventional policies Unconventional approaches Effectiveness of unconventional policies Exit

3 Reasons to go unconventional Large shock to aggregate demand Strains in financial markets –Elevated spreads –Disrupted transmission mechanism –Frozen credit markets Zero interest-rate floor

4 Central Bank Assets and Policy Rates

5 Options for unconventional policy Commit explicitly to keeping policy rates low Provide broad liquidity to financial institutions Purchase long-term Treasury securities Intervene directly in impaired credit markets

6 Commitment to low policy rates Aims at anchoring market expectations that monetary stimulus will not be withdrawn until durable recovery is in sight Easy to announce; useful when policy uncertainty is high Effectiveness hinges on credibility; commitment has value only to the extent that it restricts future options So far – United States and Canada

7 Provision of liquidity Frictions in term money markets may necessitate going beyond overnight lending –Counterparty risk –Strains on liquidity –Shortage of acceptable collateral Options include offering liquidity –At longer maturities –To a wider set of financial institutions –Against shakier collateral –Anonymously

8 Provision of liquidity May be easy to implement; relatively little credit risk; no market risk; reduces risk of bank runs; if target is bank reserves, policy stance is easy to monitor and communicate May not translate into credit to real economy if financial intermediaries are short of capital and seek to deleverage All major central banks undertook a variety of measures in this category

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11 Credit Market Intervention Purchases of private-sector assets by central bank –Commercial paper, corporate bonds, asset- backed securities Credit to financial institutions for purchase of private securities –Securities can be used as collateral Direct lending to non-financial private sector

12 Credit Market Intervention May be more effective than going through banks when banks are broken Signaling value – doing all you can Can be selective, target particularly important and distressed markets Presents logistical challenges Exposes central bank to credit risk Gives central bank role in credit allocation, may distort relative prices

13 Credit Market Intervention U.S. – large scale; BoE, BoJ, ECB – small scale

14 Purchase of government bonds Aims to flatten yield curve if low policy rates and commitment to keep them low does not translate into low long rates Rates on government bonds are a benchmark for pricing many private securities Banks can use extra reserves to extend new credit

15 Purchase of government bonds Familiar operations Minimum credit risk Some market risk May signal commitment to keep accommodative policy Operate in deep, liquid markets –Substantial purchases may be needed to move rates –May have little impact on prices of private, risky securities

16 Bond Purchase Commitment U.S. – $300 bn (2% of GDP) by end- October, 2009 UK – £175 bn (12% of GDP) by early November, 2009 Japan – increased purchases to annual rate of ¥21.6 trillion (4% of GDP) – but net purchases are much smaller ECB and BoC – no bond purchases

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18 Credit Easing vs. Quantitative Easing Quantitative easing refers to outright purchases of financial assets through the creation of excess settlement balances (that is, central bank reserves) Credit easing refers to purchases of private sector assets in certain credit markets that are important to the functioning of the financial system but that are temporarily impaired. Source: Bank of Canada

19 What accounts for diversity? Disagreement on usefulness of explicit commitment Differences in country circumstances −Depth of recession −Impairment of financial system −Role of banks −Institutional arrangements −Actions of non-monetary authorities

20 Effectiveness of Unconventional Policies Difficult to ascertain –Too much is going on at the same time –What is the counterfactual? –Substitutability between supported and unsupported assets –What matters – announcement or implementation? Look at prices and volumes in supported and unsupported markets

21 Effectiveness In our view, liquidity provision and credit intervention policies have largely been effective in alleviating market stress and facilitating flow of credit Conditions in financial markets have improved Spreads fell more in supported than in unsupported markets –Conforming vs. jumbo mortgages –High-rated vs. low-rated ABCP –TALF-eligible ABS vs. HEL ABS Volumes picked up and maturity lengthened in ABCP markets

22 Improvement in broad liquidity indicators and in markets supported by the central banks

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25 Effectiveness of government bond purchases is questionable

26 Exit – What are the Concerns? Banks hold large excess reserves Will liquidity translate into fast credit growth and inflation? Can the central bank control monetary conditions with outsized balance sheet? Would balance sheet contraction be disruptive? Will monetization of government deficits loosen fiscal discipline and push up long term yields? Loss of central bank independence and credibility

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28 Exit Can Be Managed With large excess capacity, low rates and high liquidity will not lead to inflation outburst, as long as inflation expectations remain anchored Central bank balance sheets will shrink to some extent automatically as financial conditions improve Central banks have adequate tools to control monetary conditions even if balance sheets remain large It is too early to actively tighten monetary policy, but exit strategies should be elaborated and communicated to the public

29 Really? Many liquidity and credit market intervention facilities are priced above normal market rates and will shrink when spreads tightenliquiditycredit Long-term assets can be sold or will run down as they mature Ability to pay interest on reserves allows central bank control its policy rate even with large excess reserves For a given size of the balance sheet, reserves can be decreased by increasing other liabilities –Reverse repos –Government deposits –Term deposits –Central bank bills or bonds

30 Conclusions Unconventional monetary policies were undertaken in response to an unprecedented aggregate demand shock and strains in the financial markets, such that traditional instruments were insufficient to deal with the crisis. They included enhanced provision of liquidity to financial institutions, credit market interventions, and, in some cases, purchases of government securities and conditional commitment to keep policy rate low for an extended period of time. Their scale and scope varied across countries depending on their circumstances.

31 Conclusions – continued Unconventional measures appear to have been effective in alleviating market stress and boosting aggregate demand. Unconventional measures do not imply an outburst of inflation down the line. Orderly exit is feasible. It is to early to actively withdraw unconventional interventions, but exit strategy should be clearly communicated to the public.

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