Benoît Coeuré: The persistence and signalling power of central
bank asset purchase programmes
Speech by Mr Benoît Coeuré, Member of the Executive Board of the European Central Bank, at
the 2018 US Monetary Policy Forum, New York City, 23 February 2018.
* * *
Accompanying slides
The financial crisis has seen central banks launch asset purchase programmes of
unprecedented scope and scale, so as to provide additional policy stimulus as interest rates
approached the lower bound. This period has yielded many insights into how these programmes
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work and their various channels of transmission. But one question that has remained open is
the relative importance of their "stock" and "flow" effects.
The issue is not so much about which of the two effects dominates. The literature is fairly clear
on this: there are sizeable announcement effects related to the stock of purchases, and these
effects materialise whenever investors receive new information about the parameters of the
purchase programme, such as its size, duration and composition. The actual impact of
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purchase operations on yields has been found to be less in comparison.
The issue is rather if it matters how a given stock of purchases is built up, and how this building
up interacts over time with the other elements of the monetary policy stance. This is especially
important for the ECB today because, as we said in our latest introductory statements, our
monetary support currently comprises three components: first, net asset purchases; second, the
stock of acquired assets and forthcoming reinvestments; and third, our forward guidance on
interest rates.
I would therefore like to use my remarks today to explore two aspects of implementing asset
purchase programmes where I still see open questions. My focus will be on the closed economy
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dimension of such operations, having addressed their international spillovers elsewhere.
The first aspect relates to the interaction between interest rate forward guidance and asset
purchases. Specifically, for a given policy intention, are policymakers able to choose the relative
intensity with which they use each of these instruments? In other words, under what conditions
will they become substitutes rather than complements?
The second aspect relates to the persistence of the effects of asset purchases. Does the stock
effect appear mainly at the time of the announcement and then fade as new shocks occur? Or
does it accumulate as the size of the central bank's portfolio rises, meaning its effect can grow
even as the flow of purchases is reduced?
I intend to argue that, at least in the euro area, empirical evidence suggests that the amount of
purchases needed to deliver a given compression of the term premium is likely to fall over time
as the acquired stock of assets increases. But crucially, once their policy objectives come closer
to being achieved, central banks can safeguard low bond yields, if judged necessary, only to the
extent they provide effective guidance on the future path of short-term interest rates.
Asset purchases and rate forward guidance
Let me start with the interaction between rate forward guidance and asset purchases.
A natural starting point for such a discussion is to recall the two main components that shape
long-term interest rates: expectations of future short-term rates and a term premium. Asset
purchase programmes can lower yields by influencing both components. Purchases compress
term premia by removing duration risk from the market. And since investors do not expect central
banks to start raising rates while they are still buying assets, purchases - in principle - also have
a signalling effect for the expected rate path.
I would argue, however, that the strength of this signalling effect is likely to depend on the degree
of uncertainty that investors have about the policy outlook. When the outlook is gloomy and
investors expect rates to remain low for long, they typically don't focus on signals that will tie the
hands of the central bank in the future. What they want to see is a clear commitment by the
central bank to counter the downside risks that are visible now. They want them to "put their
money where their mouth is".
But when policy has succeeded in shifting upwards the distribution of risks around the growth
outlook, and expectations of an end to asset purchases start to mount, uncertainty about the
future path of rates begins to increase. Then, the interaction between the horizon of the purchase
programme and rate forward guidance becomes more important.
Let me illustrate this point by referring to our own experience of buying assets.
From the time we started purchasing assets in September 2014, to the time we expanded the
programme to include public sector securities in March 2015, we observed a strong reaction in
long-term yields as investors started to anticipate our future interventions. The ten-year Bund
yield fell by nearly 80 basis points in that period alone. The launch of our asset purchase
programme had undoubtedly erased concerns among market participants that the ECB might
not be serious about achieving its price stability objective. We "put up", in other words.
But when, in December 2015, we extended the programme by six months and announced the
reinvestment of future principal repayments, the reaction was much less favourable. Although the
extension of the programme alone increased the expected stock of purchases by €360 billion,
the ten-year Bund yield rose by 20 basis points upon announcement.
Clearly, market reactions were at odds with the standard thinking on the transmission of asset
purchases. According to the signalling channel, our December 2015 actions should have helped
to push out expectations of a rate lift-off. They should have provided strong forward guidance on
the expected future path of short-term rates, thereby putting downward pressure on long-term
rates. And the sizeable additional removal of bonds from the market should have weighed on
term premia. None of this happened, however. As you can see on my first slide, the expected
period of time until a rate lift-off in fact became shorter after our December 2015 announcement.
This suggests two things. First, it cannot be excluded that markets may have taken our
backloaded actions - the extension pertained to a period that would only start nine months from
the announcement date, while future reinvestments under the public sector purchase
programme would not start until 15 months later - as a sign of hesitation on the part of the
Governing Council to follow through on our commitment to bring inflation back to our aim. In the
eyes of investors, we failed to "put up".
This in turn implies, and this is my second point, that when markets perceive a central bank's
inflation aim to be at risk, asset purchases are a commitment device that reassures investors
that the central bank is unwilling to tolerate a protracted period of low inflation, on top of their
direct impact on financial conditions.
As such, the signal they send about the future path of short-term rates is of a secondary nature.
Purchase pace and envelope are what matter most. This is also consistent with findings in the
literature which show that the signalling effect of asset purchases is typically moderate at the
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time they are announced.
However, we have also seen that, as the outlook improves, the signal that asset purchases send
regarding the likely date of a first rate hike becomes increasingly important for anchoring the
medium to long-term segment of the curve.
This can also be seen in the greater sensitivity of forward rates to macroeconomic news, as my
next slide shows. As expectations of an end to asset purchases build up in the market, expected
short-term rates in one year's time have become increasingly more responsive to changes in the
data.
At this point, the close relationship between expectations of a rate lift-off and the purchase
horizon opens room for the central bank to recalibrate the relative intensity of the instruments it
uses to secure appropriate financial conditions. For example, a shorter purchase horizon could
be combined with stronger rate forward guidance so as to mitigate the risk of investors unduly
bringing forward their rate expectations.
The terms of this recalibration will largely depend on three considerations.
The first relates to financial stability considerations - that is, the potential side effects of central
banks being active players in bond markets for a protracted period of time. Should too long a
presence unduly affect market liquidity or market structures, then this could tilt the balance away
from purchases and towards stronger guidance on rates.
Of course, low-for-long short-term interest rates also have financial stability implications. But this
is not the point. The point is that asset purchases are necessary at the lower bound to reinforce
forward guidance, but this necessity gradually declines as the outlook improves.
The second consideration relates to clarity on communication, in particular when guidance on
rates is linked to the end date of the asset purchase programme. In the ECB's case, we have
stated that we expect rates to remain at their present levels "well past the horizon of our net
asset purchases".
This has proved a powerful way to dispel concerns about expectations of a premature tightening
as we gradually succeeded in shifting upwards the distribution of risks around the inflation
outlook. You can see this clearly on my previous slide. After we introduced the notion of "well
past" in March 2016, and increased the pace of purchases, the expected time to a lift-off was
pushed out measurably.
But as a central bank gets closer to reaching its inflation aim, risks become larger that
uncertainty around the horizon of purchases may inject volatility into the expected future rate
path, even well ahead of the signalled purchasing intentions of the central bank.
This might not only affect financial conditions, but also blur the signals central banks rely on to
gauge market expectations. For example, over the course of the last two months we saw a
repricing in the EONIA forward curve. But it is difficult to tell with certainty whether this was the
result of a re-appraisal by markets of the meaning of "well past" in our forward guidance - that is,
a genuine adjustment of interest rate expectations - or merely a reflection of changes to the
expected length of our asset purchase programme.
More clarity on future rates could then in principle help condense the focus of market uncertainty
from two variables - the end-date of asset purchases and the definition of "well past" - to one
variable, which the central bank can control with its communication.
This is in fact very similar to what my colleague Peter Praet had said recently, namely that "as
we progress towards a sustained adjustment in the path of inflation and approach the time when
net purchases will gradually come to an end, the residual monetary support needed to assist the
economy in its transition to a new normal will increasingly come from forward guidance on our
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policy rates."
Importantly, this is not about the sequence of instrument normalisation. In the ECB's case, the
Governing Council has confirmed it repeatedly. It is rather about the ability of the central bank to
effectively steer market conditions in a way consistent with its price stability mandate.
But whether it would in fact achieve this depends in part on the third consideration, namely the
strength of the "stock effect" - that is, the persistence of the effects of the stock of bonds held by
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the central bank on its balance sheet under a commitment of reinvestment.
If the effects of purchases dissipate quickly, a shorter purchase horizon could lead to term
premia rising even as interest rate expectations remain well anchored by forward guidance.
Financial conditions would then tighten.
But if the effectiveness of asset purchases rises with the stock of assets already acquired - if
there is some "crossover point" where the stock effect becomes more important than the
continued flow of purchases - then a reduced pace of purchases would not unduly decompress
the term premium.
This brings me to my second question, which concerns the persistence of asset purchase
programmes.
The persistence of asset purchase programmes: theory
Unfortunately, surprisingly little is known about this issue in the academic literature, mainly due to
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the preponderance of event studies in existing research. Those studies have little to say about
the persistence of asset purchase programmes long after they are announced. Other studies
using time-series analysis suggest that the expected persistence of the supply shock is
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important.
What I would like to offer today is a way of thinking about it which, I believe, could shed some light
on how the stock effect of purchases works in practice, how it evolves over time and why it might
differ between jurisdictions.
I will look at some of the empirical evidence in a minute, but I would first like to structure my
thoughts with the help of a simple stylised supply and demand diagram like the one you can see
here on the left-hand side of my next slide. This is an easy way to visualise the interaction
between a central bank acting as a buyer of securities and potential sellers in the secondary
market.
For ease of illustration, the demand curve of the central bank is vertical - that is, the central
bank's demand can be expected to be price-inelastic, by and large. Our objective is not to
minimise costs or to maximise profits: it is to create the financial conditions required to achieve
price stability. This is without prejudice, of course, to our legal requirement to act in accordance
with the principles of an open market economy in which prices are discovered through private
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supply and demand.
The supply curve, by contrast, is unlikely to be just a linear upward-sloping curve. It is likely to be
a convex function. Let me explain why. As demand rises, supply is likely to become increasingly
constrained. Inventory holdings by intermediaries shrink, while other marginal sellers are likely to
have a higher reservation price.
For example, pension funds typically need to invest a significant portion of their assets in safe
long-dated bonds to match their liabilities. Many other market participants need to keep high
quality liquid assets for regulatory reasons. These investors will typically sell only for a higher
premium.
It is now easy to see that the effectiveness of purchases can be expected to increase over time.
A given outward shift of our demand curve, through, say, an extension of our asset purchase
programme, will meet a supply curve that gets steeper as bonds become scarcer. The "bang for
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the buck" rises.
On the right-hand side you can see how this translates into the stock effect.
Central bank asset purchase programmes effectively constrain the supply of bonds available to
private price-sensitive investors. So you can think of it as an inward shift of the supply curve.
However, the demand curve for private investors, unlike that for central banks, is unlikely to be
price-inelastic. It is pictured here as a standard downward-sloping linear demand curve.
The implication is that if central banks have succeeded in shifting the supply curve sufficiently
inwards, then prices may become less sensitive even when purchases start being reduced.
Consider the example of an adverse demand shock, shown on the right-hand side - that is,
investors will want to sell bonds as the economic outlook improves and expectations of higher
rates mount.
You can see that the price impact of such a change in demand is likely to be more contained
than in a situation where supply is greater. The reason is that any new supply would be absorbed
with smaller price changes, given the scarcity of the underlying asset.
The persistence of asset purchase programmes: evidence
Both of these stylised representations are supported by the data.
On my next slide you can see that, as our purchase programme has progressed, we have
indeed seen a shift towards investors with a higher reservation price as marginal seller to the
Eurosystem. We are now increasingly purchasing assets from pension funds and insurance
companies rather than from non-residents, who are less likely to have a statutory need for euro
area government bonds. The implication is that our purchases are likely to have become more
effective over time.
On the next slide you can see how the cumulative effect of these purchases on private bond
supply has created the conditions for strong stock effects. What you can see here is an estimate
of the share of outstanding central government bonds held by the private sector - the so-called
"free float" - for three euro area countries that investors consider safe.
The free float is constructed by computing the fraction of outstanding bonds that is held neither
by the Eurosystem under the public sector purchase programme nor by foreign central banks as
part of their foreign exchange reserves. In each case the free float has shrunk significantly since
our asset purchase programme began.
This is especially the case for German Bunds, which is of particular importance for the euro area
as Bund prices effectively determine the quasi-risk free curve in the euro area. According to our
estimates, less than 10% of the outstanding stock of German Bunds might currently be in the
hands of private investors. But this estimate needs to be treated with caution as it relies on a
number of assumptions regarding the allocation of overseas foreign exchange reserves.
As my next slide shows, the drop in the free float has had a significant impact on price dynamics.
What you can see here is the empirical relationship between the Bund free-float and the term
premium investors require for holding long-term Bunds. We exclude here the period around the
financial and sovereign debt crises.11
Two things stand out. First, there is a clear positive relationship between the amount of duration
risk private investors are expected to hold and the compensation they require for holding it.
Second, it is easy to see that the relationship is non-linear and that the term premium has
become less responsive at lower free float levels. This is the stock effect at work.
The amount of bonds available to private investors is currently so low that investors are willing to
absorb new bonds without requiring much higher compensation. Supply is effectively
constraining demand. This becomes clear if we recall the statutory needs of many investors for
safe and liquid assets. In these circumstances, only very large changes in the expected supply of
bonds can cause yields to rise more meaningfully.
This framework helps us explain why, in the course of the last year, Bund yields traded in a tight
corridor despite the measurable decline in our purchase pace from €80 billion per month in
March 2017 to €30 billion as of January this year.
Of course, stock effects have not prevented Bund prices from falling in line with the strong
economic recovery: an improving outlook will naturally drive yields higher as expectations of the
future rate path are revised. But what stock effects have achieved is to temper the impact of both
domestic demand shocks and foreign spillovers on euro area term premia.
In some ways, there are parallels with the discussion of nonlinearities in the Phillips curve: here
too we see evidence that price increases only start to accelerate more forcefully once the
economy moves into the steeper part of the curve. Unlike in the labour market, however, current
and future reinvestments of principal repayments on our asset purchases should ensure that
expected supply in the Bund market remains below the threshold at which price effects may
increase in strength.
Squaring the stock effect in the United States and the euro area
Another way of demonstrating the non-linear nature of stock effects is to consider the very
different market reaction we saw here in the United States as expectations of an end to asset
purchases mounted, in particular the famous "taper tantrum" in mid-2013.
Indeed, one argument put forward by those who are sceptical of the persistence of stock effects
is that the announcement of tapering led to an immediate repricing of the market for US
Treasuries. As you can see on my next slide, this cannot systematically be explained by an
upward revision in interest rate expectations. Expected rates jumped twice but came back.
Rather, the repricing was driven by a steep and lasting increase in the term premium on ten-year
US Treasuries - by more than 130 basis points in less than three months, as you can see on the
right-hand side. This is hard to square with persistent term premium effects of central bank asset
purchase programmes.
Yet, we have to remember that, even after various rounds of quantitative easing, the Federal
Reserve held only around 20% of outstanding marketable US debt at the time. Even when
accounting for the holdings of other price-insensitive investors, such as foreign central banks,
private investors still held around half of marketable US Treasuries. Remember that it may be
less than 10% in the case of German Bunds.
In part, this reflects the fiscal environment prevailing at the time the asset purchases were taking
place. Demand on the part of the Federal Reserve has consistently been lower than net new
issuance. This means that private sector holdings of government bonds continued to grow while
the Federal Reserve's purchase programmes were in place, albeit at a slower pace than would
otherwise have been the case. In the euro area, by contrast, purchases by the Eurosystem were
significantly larger than new net issuance, producing a cumulative contraction in the share of
privately held bonds.
In other words, US Treasuries around the taper tantrum episode were likely still in sufficient
supply to satisfy the demand of private investors, which made bond prices more sensitive.
Indeed, on my next slide you can see the same relationship I just showed for the Bund for US
Treasuries - that is, the ten-year Treasury term premium against the free float. These are the
black dots.
You can see clearly that the United States was always in a steeper part of the curve, where
supply was unable to anchor term premia. You can also see that at these levels of the free float,
the relation between term premia and free float was not much different in the Bund market - you
can see this when looking at the red dots.
On my next slide you can see how this might have affected market reactions in periods when the
outlook had started to brighten. Here I show cumulative changes of a model-based shock
decomposition of long-term yields, starting in May 2013 for the United States and in May 2017 for
the euro area.
You can see that while in the United States a combination of macroeconomic, policy and foreign
shocks were driving yields higher, in the euro area domestic shocks were appreciably more
moderate, and foreign shocks were even putting downward pressure on yields. This happened
despite a broadly comparable economic backdrop. Stock effects might therefore have helped to
insulate the euro area from foreign spillovers and to temper domestic shocks.
Bond yield developments relative to the overnight index swap (OIS) curve corroborate this view.
You can see from the left-hand side of the next slide that in the euro area, at both two-year and
ten-year durations, the spread between German Bunds and corresponding OIS rates turned
negative as we started implementing the asset purchase programme and consistently and
gradually widened over time as the implementation of our asset purchases proceeded. This is a
crude but reliable gauge of the effect of stocks on the term premium.
The reason is that, if changes in the Bund term premium were being driven by risk factors alone
- say, higher inflation expectations or uncertainty about monetary policy - we would expect the
Bund-OIS spread to be fairly constant. Such factors typically affect both markets as swap
dealers use positions in Bunds to hedge interest rate risk on swaps. But the fact that the spread
is widening over time suggests that it is not being driven by common factors, but rather by
factors specific to the Bund market. The most plausible candidate for a secular effect of this kind
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is supply-demand effects induced by a shrinking free float.
In the United States, by contrast, as you can see on the right-hand side, the ten-year spread was
negative at various points during the three quantitative easing programmes, but there was no
persistent widening as we have seen in the euro area, suggesting a role for factors other than
bond scarcity caused by central bank interventions.
Conclusion
So what are the implications of all this for future monetary policy?
The non-linear nature of the stock effect implies that the amount of purchases needed to deliver
a given compression of the term premium is likely to fall over time as the acquired stock of
assets increases. Once the "crossover point" has been passed, additional purchases become
less necessary to contain the term premium at low levels.
With the current share of the Bund free float constituting only a small fraction of the total
outstanding, we can be confident that we have passed this threshold in the euro area, in
particular as current and future reinvestments will ensure that the amount of duration risk to be
borne by price-sensitive private investors will increase only very moderately over time.
This means that, in the future, the Eurosystem can retreat as buyer in the market without risking
an unwarranted decompression of the term premium. But it can contain volatility, and safeguard
appropriate financial conditions, only to the extent that it provides effective guidance on the
expected future path of short-term interest rates.
Thank you.
1
See, e.g., Krishnamurthy, A. and A. Vissing-Jorgensen (2011), "The Effects of Quantitative Easing on Interest
Rates: Channels and Implications for Policy", Brookings Papers on Economic Activity, Fall; and Andrade, P., J.
Breckenfelder, F. De Fiore, P. Karadi and O. Tristani (2016), "The ECB's Asset Purchase Programme: An Early
Assessment", ECB Working Paper No 1956.
2
See D'Amico, S. and T. B. King (2013), "Flow and stock effects of large-scale Treasury purchases:evidence on
the importance of local supply", Journal of Financial Economics 108(2): 425-448; and De Santis, R. and F.
Holm-Hadulla (2017), "Flow effects of central bank asset purchases on euro area sovereign bond yields:
evidence from a natural experiment", ECB Working Paper No 2052.
3
See Coeuré, B. (2017), "The international dimension of the ECB's asset purchase programme", speech at the
Foreign Exchange Contact Group meeting, 11 July; and Coeuré, B. (2017), Monetary policy, exchange rates and
capital flows", speech at the 18th Jacques Polak Annual Research Conference hosted by the International
Monetary Fund, Washington D.C., 3 November.
4
See, e.g., Altavilla, C., G. Carboni and R. Motto (2015) "Asset purchase programmes and financial markets:
lessons from the euro area", ECB Working Paper No 1864; and Gagnon, J., M. Raskin, J. Remache, and B. Sack
(2011), "The Financial Market Effects of the Federal Reserve's Large-Scale Asset Purchases", International
Journal of Central Banking 7 (1): 3-43.
5
See Praet, P. (2017), "Communicating the complexity of unconventional monetary policy in EMU", speech at the
2017 ECB Central Bank Communications Conference, Frankfurt am Main, 15 November.
6
In what follows I neglect the possible impact on the term premium of the declining duration of the acquired stock
of assets.
7
See, e.g., Gagnon et al. (2011, op. cit.), Krishnamurthy and Vissing-Jorgensen (2011, op. cit.), and Altavilla et al.
(2015, op. cit.).
8
See Li, C. and M. Wei (2013), "Term Structure Modeling with Supply Factors and the Federal Reserve's
LargeScale Asset Purchase Programs", International Journal of Central Banking, 9(1), 3-39; Greenwood, R., S.
Hanson and D. Vayanos (2015), "Forward Guidance in the Yield Curve: Short Rates versus Bond Supply", NBER
Working Paper No 21750; and Blattner, T.S. and M. Joyce (2017), "Net debt supply shocks in the euro area and
the implications for QE", ECB Working Paper No 1957.
9
This is one reason why, for example, the ECB's asset purchases in sovereign bond markets are subject to an
issue and issuer limit.
10
See Coeuré, B. (2017), "Asset purchases, financial regulation and repo market activity", speech at the ERCC
General Meeting on "The repo market: market conditions and operational challenges", Brussels, 14 November.
11
During the crises, term premia were often affected by the extraordinarily high degree of uncertainty and volatility,
which makes them much more difficult to interpret.
12
For an early discussion see Coeuré, B. (2017), "Bond scarcity and the ECB's asset purchase programme",
speech at the Club de Gestion Financière d'Associés en Finance, Paris, 3 April.