Charles Bean: Global aspects of unconventional monetary policies
Panel remarks by Mr Charles Bean, Deputy Governor for Monetary Policy of the Bank of
England, at the Federal Reserve Bank of Kansas City Economic Policy Symposium, Jackson
Hole, Wyoming, 24 August 2013.
* * *
Since the demise of Lehman Brothers and the subsequent exceptional contraction in
demand in 2008-9, central banks have not only expanded the range of their liquidity
operations in order to restore financial stability, but also adopted a range of unconventional
monetary measures in order to raise aggregate demand once short-term policy rates had
reached their effective lower bound. Those measures include: large-scale purchases of
government bonds and private securities (quantitative easing); selective actions to support
the flow of credit; and guidance over the future path of policy rates.
While I believe these policies helped the advanced economies to avoid some of the worst
downside scenarios, they have proved controversial - particularly quantitative easing -
provoking plenty of criticism, both at home and abroad. Before I turn to the particular focus of
this conference, namely the global consequences, let me say a few words on the domestic
costs and benefits.
Some have questioned whether quantitative easing works at all. In both the United Kingdom
and the United States, central bank reserves pay the policy rate and are consequently close
substitutes for Treasury bills. The only differences are that just banks can hold reserves and
reserves can be turned straight into cash at the central bank, whereas Treasury bills would
have to be sold or repo'd out first. Under Ricardian equivalence, quantitative easing of the
sort undertaken by the Bank of England and the Federal Reserve should then be irrelevant
because private agents internalise the tax implications of the associated changes in the
consolidated public sector balance sheet.
I think the empirical evidence from the growing number of event studies and the like strongly
suggests that this is not the case and that market imperfections give the policy traction by
reducing term premia. This, I believe, was particularly true during the worst of the post-crisis
recession, though it may have become less so as markets have returned towards normality.
That is reinforced by recent market movements in response to heightened anticipation that
the Federal Reserve will shortly begin to taper its purchases.
A more serious objection is that they are simply the wrong policy to deal with the problem at
hand. Low policy rates and quantitative and credit easing all seek to encourage the
intertemporal switching of spending from the future to the present. But, according to the
critics, that just leads to further debt accumulation and is inimical to the adjustment
necessary to unwind the excesses of the pre-crisis period (see Rajan, 2013, for a lucid
exposition of this view).
The distinction here is between policies that are designed to bolster deficient aggregate
demand and those that facilitate the necessary reduction in indebtedness and unwinding of
the misdirected investments - most obviously in housing and construction - made before the
crisis. The latter requires balance sheet repair of households and banks, including the writing
down of debts that cannot be plausibly repaid and the closure of unviable businesses. That in
turn allows resources to be reallocated to where they can be used more productively.
Now there is some validity to this critique. Bolstering aggregate demand through sustained
low interest rates and quantitative and credit easing will indeed tend to work against the
desired rebalancing of demand away from consumption towards saving and net exports -
this is what the previous Governor of the Bank of England christened the "paradox of policy"
(see King, 2009). And the present period of low interest rates may indeed allow some
businesses to survive that do not have a viable long-term future.
But against that, it is easier for households, businesses and banks to repair balance sheets
when demand is strong than when it is weak. A sustained period of weak demand may also
push many businesses that are perfectly viable in the long run into insolvency, especially if
the supply of credit is impaired. And a long period with underutilised resources may cause
durable damage to the supply capacity of the economy through a variety of hysteretic
mechanisms, such as skill atrophy on the part of the unemployed and foregone opportunities
for learning by doing.
In any case, to me this sets up a false dichotomy. There are both Keynesian and Hayekian
dimensions to the post-crisis environment. A "two-handed" approach is called for, in which
supportive aggregate demand policies on the one hand are complemented by policies that
facilitate the necessary restructuring, particularly of the banking sector, on the other. So
rigorous evaluation of the assets on banks' balance sheets, followed by recapitalisation,
should be the order of the day (see Tucker, 2013, for a similar perspective). The United
States has been a model in this regard. In Europe, we have lagged a little, but are now
catching up. In the United Kingdom, the Prudential Regulation Authority, at the instigation of
the Bank's Financial Policy Committee, has required several of our major banks to
strengthen their capital buffers against potential losses. And, in the euro area, the European
Central Bank is about to undertake an in-depth health check of banks' balance sheets.
Of course, there are some risks attached to pursuing such accommodative monetary
policies. Quantitative easing can threaten future financial stability if it leads investors into
excessively leveraged positions in the search for higher yields. Moreover, a long period of
low interest rates can lead people to overestimate the debt they can safely manage if interest
rates were to normalise. Central banks must be alive to these risks and deploy appropriate
prudential tools in mitigation.
Furthermore, if central banks do seek to sustain demand, it can dull the incentives for private
agents and governments to undertake the necessary adjustments and reforms. Such moral
hazard has surfaced from time to time in the euro area during the past couple of years.
Accommodative monetary policy can buy time, but it is a policy best suited to filling in a
temporary hiatus in demand, not a long-lived shortfall: it is a bridge, not a pier.
Let me turn now to the international consequences of these unconventional monetary
policies. There are several interrelated channels of propagation. First and most
contentiously, they may put downward pressure on the exchange rate, a purely
"beggar-myneighbour" channel. It was that which prompted Guido Mantega, the Brazilian Finance
Minister, to charge advanced economy central banks with engaging in a "currency war".
Central banks in other countries may then respond by setting lower policy rates in order to
lessen the appreciation of their currencies. One way to see whether this has happened is to
look at the departures from what a standard Taylor rule would imply; the evidence surveyed
by He and McCauley (2013) suggests that Asian central banks have indeed shaded down
their policy rates in response to looser US policies.
Further down the yield curve, large-scale asset purchases will reduce yields not only in the
markets where the purchases are made, but also in the markets for substitute assets through
portfolio balance effects. There are several papers that find the lower bond yields from the
large-scale asset purchases of the major central banks have translated into lower yields in
other local currency bond markets that are integrated into global bond markets. For instance,
Neely (2010) finds evidence of significant spillovers from the Federal Reserve's LSAPs to
other advanced economy sovereign bond markets, with yields falling on average by around
half the associated fall in US 10-year yields, while Moore, Nam, Suh and Tepper (2013) find
that emerging economy government bond yields fell by around a sixth.
In addition, capital flows out of the stimulating jurisdiction can encourage an expansion in the
supply of credit and also a switch into foreign currency denomination if the local currency is
expected to appreciate. Unless well managed, that can lead to increased financial
vulnerabilities further down the road. Yet the results of Fratzscher, Lo Duca and Straub
(2013) on the respective impacts of different tranches of the Fed's quantitative easing
suggest that these flow effects have not always operated in the same direction. In particular,
they find that the first phase, QE1, triggered portfolio rebalancing out of emerging economies
into US equity and bond funds - perhaps reflecting the role of QE1 in reducing tail risks in
the United States - while the opposite occurred under QE2.
Finally, to the extent that the unconventional policies are successful in their aim of boosting
activity in the originating country, they will generate aggregate demand spillovers onto other
countries through increased demand for imports.
It should be obvious from this discussion that the spillovers from unconventional monetary
policies are diverse in nature and ambiguous in overall sign. But from the point of view of the
world as a whole, there has to be a strong presumption that these unconventional monetary
policies have been expansionary. And with the world economy still suffering from deficient
global aggregate demand and underutilised resources that surely has to be a good thing.
That said, I would not wish to underplay the difficulties that some recipient countries have
faced in absorbing large inflows of relatively short-term capital in a safe fashion.
The presence of these complex spillovers has led to suggestions that monetary policies need
to internalise these spillovers and be better co-ordinated (see e.g. Committee on
International Economic Policy and Reform, 2011). While I can accept the logic of this, I am
afraid I do not think we know nearly enough about the magnitude - or even the sign - of
these spillovers to make this a viable option. The best we can probably aspire to is directing
monetary policies to achieving domestic price stability in a sensible manner and seeking to
communicate our policy intentions as clearly as possible.
Let me finish with a few words on the exit from unconventional monetary policies. While it
may still be a way off, we know it will come eventually. And the recent market volatility
prompted by heightened expectations of imminent tapering in the rate of asset purchases by
the Federal Reserve has provided a salient reminder that it may not be smooth. Moreover,
although the adoption of accommodative policies was synchronised across the advanced
economies, the heterogeneous nature of the recovery, with the United States leading the
way and Europe bringing up the rear, means that exit is unlikely to be synchronised, which
will complicate matters.
The international spillovers mentioned earlier can obviously be expected to operate in
reverse on exit. And indeed, we have just seen such synchronised increases in long-term
sovereign bond yields internationally, together with capital outflows from emerging
economies and associated downward pressure on their currencies. But for these countries,
the greatest danger during exit will probably lie in the risk of future financial sector disruption
if outflows expose currency mismatches on bank and corporate balance sheets.
For advanced economies, particularly those lagging behind on the road to exit, there is a risk
that market participants see tightening moves in, say, the United States as indicating that
tightening is imminent elsewhere. Although synchronised movements in bond rates is
unsurprising given the high degree of substitutability between relatively safe sovereign
bonds, synchronisation at the short end of the yield curve is not warranted if cyclical positions
differ.
Such concerns prompted the Monetary Policy Committee of the Bank of England and the
Governing Council of the European Central Bank to push back against the recent upward
movements in the short end of the yield curve in our respective policy statements in July. The
MPC took this further at our latest meeting by offering explicit forward guidance on the future
path of policy rates and asset purchases. The guidance is similar to that already adopted by
the Federal Open Market Committee, but differing in details that reflect the different position
of the UK economy. In particular, we signalled our intention not to countenance tightening
policy until unemployment has fallen to at least 7%. In addition, while our guidance is subject
to two price stability overrides similar to those of the Fed relating to internal and external
measures of inflation expectations, we have also added a financial stability override
determined by our Financial Policy Committee.
This guidance is intended primarily to clarify our reaction function and thus make policy more
effective, rather than to inject additional stimulus by pre-committing to a time-inconsistent
"lower for longer" policy path in the manner of Woodford (2012). While such a
timeinconsistent policy may be desirable in theory, in an individualistic committee like ours, with a
regular turnover of members, it is not possible to implement a mechanism that would credibly
bind future members in the manner required.
Nevertheless, by reducing uncertainty about our behaviour, we are aiming to encourage
households and businesses to spend and invest. The knowledge that monetary policy will not
be tightened until the UK's fledgling recovery is secured should boost confidence. Moreover,
it should reduce the likelihood that the present expansionary monetary stance is withdrawn
prematurely through an upward movement in market interest rates. Short-term yields have
moved up since our announcement on a string of good news about the economy, but the
unemployment threshold, by serving as a reminder of just how much growth is needed to
regain lost ground, should temper the extent of any tightening. Indeed, for that reason,
guidance is potentially more valuable during exit than during entry. Finally, given the
uncertainty about the causes and durability of the recent exceptional weakness in
UK productivity growth, it also provides a robust framework within which to test the scope for
economic expansion without jeopardising price or financial stability.
While guidance - and good central bank communication more generally - will be important
during exit, I doubt very much that good central bank communications alone can ensure that
it will be completely smooth. When a central bank's reaction function is not well understood,
market interest rates tend to respond to policymakers' actions in response to economic data.
But when the reaction function is well understood, market interest rates will instead respond
earlier as the economic data unfolds. Although there are benefits to the market more
accurately anticipating a given policy decision, because the data are likely to evolve in an
imperfectly predictable fashion, so will market interest rates and asset prices.
In sum, then, exit will be challenging, both for the central banks in the countries withdrawing
stimulus and those in other countries that will be affected by the international spillovers. But
we do have the luxury of knowing that it will come eventually and can plan for it
appropriately. And when it does come, it should be against the background of a markedly
better economic outlook in the advanced economies. That itself would be a most welcome
change.
Thank you!
References
Committee on International Economic Policy and Reform (2011). Rethinking Central
Banking, Brookings Institute, Washington DC.
Fratzscher, Marcel, Marco Lo Duca and Roland Straub (2013). "On the International
Spillovers of US Quantitative Easing", European Central Bank Working Paper #1557.
King, Mervyn (2009). Speech to Confederation of British Industry, Nottingham, 20 January.
He, Dong and Robert McCauley (2013). "Transmitting Global Liquidity to East Asia: Policy
mimeo, Bank for International
Rates, Bond Yields, Currencies and Dollar Credit",
Settlements.
Moore, Jeffrey, Sunwoo Nam, Myeongguk Suh, and Alexander Tepper, (2013).
"Estimating the Impacts of the U.S. LSAPs on Emerging Market Economies' Local Currency
Bond Markets", Federal Reserve Bank of New York Staff Report #595.
"The Large Scale Asset Purchases had Large International
Neely, Christopher (2010).
Effects", Federal Reserve Bank of St. Louis Working Paper #2010-018D.
Rajan, Raghuram (2013). "A Step in the Dark: Unconventional Monetary Policy after the
Crisis", Andrew Crockett Memorial Lecture, Bank for International Settlements, 23 June.
Tucker, Paul (2013). "A New Regulatory Relationship: The Bank, the Financial System and
Speech at the Institute for Government,
the Wider Economy", London.
Woodford, Michael (2012). "Methods of Policy Accommodation at the Interest Rate Lower
Bound", Federal Reserve Bank of Kansas City Symposium, Jackson Hole.