Academic journal article Business Economics

Unconventional Monetary Policy and the Role of Central Banks

Academic journal article Business Economics

Unconventional Monetary Policy and the Role of Central Banks

Article excerpt

Abstract Over the last few years, central banks in industrial countries have undertaken a variety of policies that deviated from ordinary monetary policy. Why were these policies used? Did they work? What will be the effect of phasing them out? And what long-term concerns do they raise? Clearly, markets were broken, and there was a need to repair them. Some of these innovative instruments seemed to have worked quite well. But now central banks are struggling to get inflation up into their target bands. Large central bank balance sheets may create needed safe, short-term instruments, but take much liquidity management away from the private sector, while tempting governments to use them for other purposes. Sober thinkers need to examine the experience of the last few years and ask again, what should central banks be asked to do and what ought to be the range of actions they can take?

Keywords Unconventional policy * Central banks * Inflation expectations * Balance sheet

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It is an honor to receive the Adam Smith Award, especially given the illustrious group of past recipients. I am humbled, and will do my best in the next half hour or so to give you something to think about. If I do not have the answers that the preceding awardees had, at least I may have some questions. What I want to talk about in my opening comments is the role of central banks, which till recently seemed largely settled.

Over the last few years, central banks in industrial countries have undertaken a variety of efforts that deviated from ordinary monetary policy. They have tried to persuade the public through forward guidance that interest rates would stay low for extended periods. They have relied on a number of programs with various acronyms, such as long-term refinancing operations (LTRO), the Securities Markets Programme (SMP), quantitative easing (QE), and so on. Most recently, we have seen negative interest rates and--from the Bank of Japan, which has always been at the forefront of innovation--yield-curve targeting. And of course, some central banks have resorted to unconventional but well-known policies such as direct exchange-rate targeting.

These interventions suggest a series of questions that can help us take stock of this extraordinary period in monetary policy: Why were these policies used? Did they work? What will be the effect of phasing them out? And what long-term concerns do they raise? The answers to these questions may offer important insights to central bankers grappling with future crises.

Clearly, markets were broken after the financial crisis. The mortgage-backed securities market in the United States and the markets for sovereign bonds in Europe spring readily to mind. A central bank inserting itself into the process and stabilizing those markets was perhaps important at that time. So the first rationale for why central banks began experimenting with unconventional monetary policy is not hard to fathom.

The second reason to intervene was to affect yields or prices. This was a more adventurous and uncharted objective, for central banks typically try and affect prices indirectly through the policy rate rather than directly. This too was perhaps thought necessary at a time when the policy rate had reached the zero lower bound. Central bankers sought to affect prices on a variety of long-term instruments--sometimes targeting a particular class of instrument with the hope that the effect would spread across classes.

The third reason for intervention was to signal commitment to a bank's particular monetary policy. If a central bank announced, for example, a purchase program for government securities, and it sent the message that so long as it was purchasing government securities, it would not tighten monetary policy, that effectively supported the notion that it would be keeping interest rates low for a long time. Quantitative easing might have been geared in some cases toward affecting yields, but a corollary intent might have been to signal "low-for-long". …

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