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|HomePublicationsBrowse ListingThe Role and Effectiveness of Unconventional Monetary PolicyConclusion|
Once interbank rates fall to zero, a central bank must rely on other “unconventional” means to impart further easing stimulus to the economy. Moreover, even if interbank rates are still positive, the existence of a credit crunch may impair the normal transmission mechanism of monetary policy, calling for unconventional measures to break the logjam. Unconventional monetary policy measures encompass three broad categories: (i) commitment effect, i.e., commitments by the central bank to maintain very low interest rates for a certain period, either conditionally or unconditionally; (ii) quantitative easing, i.e., targeting the level of current account balances of the central bank; and (iii) qualitative or credit easing, which involves purchases of targeted assets to lower rates and/or increase liquidity in the target market.
The empirical literature examining the effectiveness of unconventional monetary policy is still limited. Moreover, a number of studies are based on simulations using macro models, so their conclusions are only as reliable as the models themselves. Nonetheless, some broad lessons can be drawn. First, most studies of the commitment effect (or duration effect) suggest that statements by a central bank regarding the duration of a policy of very low or zero interest rates do provide new information to the market and tend to pull down longerterm interest rates. However, the inevitable uncertainty regarding the future course of the economy and monetary policy means that the impact of such measures tends to be seen mainly in shorter-term interest rates of, say, one- to two-year maturity, while the impact on longer-term rates is less clear.
The literature on the effects of quantitative easing (QE) monetary policy is less conclusive, especially when one accounts for other announcements by the central bank. The most definitive studies, e.g., Baba et al. (2005b) and Bernanke, Reinhart, and Sack (2004), do not rule out some influence, but find it to be secondary to that of the commitment effect. Some studies using VAR models have found a transmission effect to the real economy via the portfolio-balancing effect, e.g., on equities (Honda, Kuroki, and Tachibana 2007), but the results do not necessarily seem convincing. However, there is evidence that quantitative easing reduced spreads in the interbank market.
Formal investigations of qualitative easing (credit easing) policy are limited, since the examples of this kind of policy are few, at least until recently. The longest-running example is the Bank of Japan's deliberate use of outright purchases of Japanese government bonds as a policy tool, which began in 2001 and was expanded in late 2008 and early 2009. The basic conclusion of the literature is that the impact on longer-term bond yields of such purchases was limited. This should not be surprising, in view of the large size of the government bond market in comparison with the size of the operations of the central bank and the impacts of many other factors, especially longer-term perceptions of the outlook for the economy and inflation. Although there is no theoretical limit to the ability of the central bank to purchase assets, practical considerations—mainly those related to the need to sell those assets later on as part of the exit strategy from unconventional policy—seem to limit the flexibility of the central bank in this area. It seems that the size of the market has to be smaller relative to the size of the operations for such operations to have an impact. Other kinds of asset purchase operations do seem to have been more successful. These include the foreign exchange swap operations conducted by the US Federal Reserve and other central banks (notably the Bank of Korea in Asia) and outright purchases of corporate paper. This suggests that central banks can use such policies successfully to deal with blockages and credit crunches in specific markets. However, for the same reason, intervention in smaller markets may also entail greater risks for the exit strategy.
Recent developments seem to support these general conclusions. The Fed's announcement of the zero-interest-rate policy and its commitment to maintain it for an extended period does seem to have been successful in lowering short-time rates and even corporate credit spreads. However, attempts by the Fed, the Bank of England, and the Bank of Japan to keep government bond yields from rising significantly look unsuccessful. On the other hand, a number of central banks have been successful in lowering spreads in interbank, commercial paper, and corporate bond markets.
Some of the main concerns regarding unconventional policy center on what to do when it has achieved its purpose and the need for such policy ends, i.e., the exit strategy. Too rapid tightening of policy could stifle an economic recovery, but inflation risks could arise if the monetary base is not reduced in a timely fashion. Large-scale sales of government bonds could push up bond yields in an undesirable way. The greatest concerns center on largescale purchases of illiquid assets, such as asset-backed securities, which would be difficult to unwind in a short period of time. The risk of losses on the central bank's balance sheet also needs to be taken into account. However, central banks have a number of tools at their disposal to limit such risks. Also, the Bank of Japan managed to exit from quantitative easing in 2006 without any great difficulty.
What is the relevance of unconventional monetary policy for Asian economies aside from Japan? Although three other economies have seen interbank rates fall to nearly zero—Hong Kong, China; Singapore; and Taipei,China—only Singapore adopted unconventional measures, and that was chiefly related to its use of the Fed's swap line for US dollar reserves. This may reflect a judgment that it was easier simply to wait for a rebound of exports. However, if growth of US consumption slows structurally, this may force Asian economies to put greater reliance on unconventional monetary policy measures during future downturns.
The need to deal with credit crunches of various kinds even when interbank rates are still positive is probably more relevant for Asian economies. During the current global financial crisis, Asian economies have mostly avoided a severe credit crunch of the kind afflicting the US and European economies, since financial sector losses have been much less. However, the Korean banking sector was unusually exposed, due to its high loan-to-deposit ratio and dependence on foreign currency wholesale funding. As a result, the Bank of Korea was most active in adopting unconventional measures, and its use of the swap line from the Fed seems to have been successful in easing the dollar shortage and bringing down interbank rates. The Bank of India also successfully implemented a number of policies to ease liquidity shortages.
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