What was conventional monetary policy in mature economies prior to the financial crisis?
Interests were set with a variatety of intstruments in a manner that could be approximated with reference to the Taylor rule, where interest rates adjusted according to inflation and fluctions in economic output.
What was the pre-eminant view of monetary policy and asset bubbles prior to the financial crisis?
That bubbles can’t really be predicted prior to their collapse and monetary policy is better suited to ‘mopping up’ the aftermath then tackling its build up. This view has now been challanged.
What has been a new focus in monetary policy following the financial crisis?
Preventing the development of asset bubles, through macroprudentual tools and banking regulations (such as Basel III) that aim to achieve financial stability and moderate asset bubbles.
Why did previus macro economic tools ineffective with dealing with the result of the financial crisis?
- Real interest rates cannot go lower then 0%
- Many major banks were threatened with insolvency and the reliable relationship with a central banks interest rate and market rates broke down. Involved were fears that banks held onto funds to increase solvency rather then onlending to the private sector as desired by the central banks.
Did the taylor rule hold following the financial crisis?
No. Due to the ineffectiveness of traditional macroeconomic tools a break from the taylor rule was required.
Name some unconventual monetary policies that have occured post GFC
- Use of negative interest rates
- Changes in target inflation rate, or abandoment of target.
- Massive expansion of bank balance sheets to influence interest rates directly rather then short-term cash rates.
What was the policy of credit easing that the US Federal Reserve pursued?
The Federal Reserve bought mortgage backed securities, increasing it’s balance sheet and providing liquidity to a market that dried up after the GFC
What was the policy called “Operation Twist” run by the US Federal Reserve?
When the Federal Reserve tried to more directly affect market interest rates by sellin short-term government bonds and using the proceeds to purchase long-term bonds, resulting in no change in their balance sheet.
What is Quantative Easing (QE)?
A policy that focus’s more on the quantity of banking reserves in an attempt to increase economy wide loaning, rather then the short term cash rate. Often involves the purchase of non-traditional assets such as long term government bonds.
What did the European Central Bank (ECB) use quantative easing policies to achieve, primarily in 2011/2012
It loaned money to European banks in exchange for collateral (often bank loans instead of government bonds). In this time there was a run on European banks towards banks in other nations. The “Repo-Operations” were designed to alleviate the funding deficulties this generated.
Did the UK Bank of England and the US Federal Reserve aim to affect market liquidity in running quantative easing policies?
No. They tried to affect the yeild (prices) on a range of assets, particularly bonds issuing loans to companies and housholds.
What are the two mechanisms through which an exchange of long-term assets for money increases spending
Preffered Habbits / Portfolio Balancing
Pricing of Duration Risk
Explain the prefered habbits / portfolio balancing of investment mechanism through which quantatitive easing affects spending
- investors have their long term assets purchase by the central bank
- because they prefer long term assets (they have a preference) they purchase long term assets with the proceeds
- the increased supply of loanable funds for long term assets decreases the interest rate on those loans.
- The decrease in yeilds make it easier for companies to raise funds, generating capital gains for households who own risky assets, increasing their wealth and hence spending.
Explain the pricing of duration risk mechanism through which quantitative easing increases spending
Purchase of medium-long term assets by a central bank reduces the duration of the stock of bonds held by the private sector, which may cause a fall in the premium required to hold duration risk or equivilently raise the price that those wishing to maintain such duration are prepared to pay for something in reduced supply.
What are some other contributory factors towards economic recovery that interfer with analysis of QE policies
- Reduction in interest rates
- Fiscal policy responses
- Spillover from other countries taking similar measures
- There are lag factors that may be long and variable
- There are a host of factors that must be controlled
What authors suggested some stupid financial market ricardian equivilence thing
Curdia and Woodford (2011)
What is the empiracal evidense of QE with regards to reducing interest rates?
Evidense, from data involving the US Federal Reserve and the UK Bank of England show that the interest rates on long term assets were reduced.
What are the headline results of the Kapetanios et al (2012) study into the affect of QE in england on real GDP and inflation?
Peak affect of 1.5% towards real GDP and 1.25% towards inflation, broadly in line with other literature.
What are the headline results of the Chung et al (2012) study into the affect of QE in the US with regards to GDP and inflation?
3% increase in real GDP, and 1% higher inflation. Suggests QE was equivilent to a 300bp rate cut.
Does the empirical evidence suggests the ECB’s efforts to increase bank funding succeded?
Yes, evidence shows it had an impact on loans and interest rates, and were effective in supporting the euro-area economy.
What does the article say about the future use (or scaling up) of QE?
- Unclear if there will be diminishing returns
Costs Unclear:
- decrease in level of interbank loaning (bad I guess)
- Bank reserves must eventually be reduced, may be very costly. See market reaction towards QE tapering in US.
- QE may be contributing towards unsustainable levels of government debt.
