Wednesday, October 16, 2019

BIS Paper on the Impact of Central Bank Stimulus Policies

The Bank for International Settlements publishes many research reports and also posts articles on its web site by central bankers from around the world. In this case, the BIS has posted a paper written by Phillip Lowe (Reserve Bank of Australia) and Jacqueline Loh (Monetary Authority of Singapore). Looking back over the last ten years they discuss the impact of central bank stimulus programs on the financial markets. 


Below is the first part of the Executive Summary from this paper. I added some bolding in spots for additional emphasis. You can find the full text of the paper here.

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Executive summary

"Central banks expanded their balance sheets on an unprecedented scale in response to the global financial crisis (GFC) and its aftermath. To address financial market dislocations and the limitations of interest rate policy as rates approached their effective lower bound, many central banks introduced special lending programmes, often followed by large-scale asset purchase programmes.

The scale of these programmes has naturally given rise to concerns about their impact on market functioning, prompting central banks to take steps to mitigate potential adverse consequences. This report prepared by a Markets Committee (MC) study group reviews the accumulated experiences and associated policy implications. It examines how the design and execution of balance sheet expansion affected market functioning, in particular, the ability of market participants to adjust positions efficiently, and whether asset prices have promptly and reliably responded to information.

The report adds to the literature by providing a systematic cross-country perspective on the effects on market functioning and related policy options. It draws on a central bank survey, analysis conducted by the study group, and a review of the available academic and policy literature. The report complements a parallel CGFS study, which reviews more broadly the effectiveness of, and lessons from, central banks’ use of unconventional policy tools.

The study group found that central bank balance sheet expansion, especially in early phases, had predominantly positive effects on market functioning. In particular, during periods of heightened illiquidity, emergency lending programmes helped ease severe funding market strains, while purchases of bonds with outsized risk premia tended to improve their underlying liquidity. Negative effects sometimes arose, but rarely tightened financial conditions materially, in part because of mitigating actions taken by policymakers. While adverse effects have often been transitory, they can have an enduring impact when policies are in place for a prolonged period.

Negative effects on market functioning have tended to be associated with elevated asset scarcity, in particular when central bank purchases or securities holdings were particularly large in relation to issuance or outstanding amounts. Scarcity at times has led to deterioration in bond liquidity metrics and increased repo specialness, although these effects were often short-lived. Declines in market making and reduced investor participation were reported in some markets, in particular where policies were in place for an extended period of time. Hence, the consequences for market functioning may not be fully evident until balance sheets normalise.

The expansion of central bank balance sheets produced sharp increases in bank reserves, contributing to a significant decline in interbank reserves trading activity. However, activity in wholesale money markets has remained robust, and central banks have kept a sufficient degree of control over short-term interest rates. 

The report documents that central banks were able to avert or attenuate side effects from balance sheet expansion on market functioning by adopting a range of mitigation strategies. These strategies were often embedded in the design of the programmes themselves, such as purchase protocols to exclude securities temporarily in high demand or to cap central bank ownership shares of individual bonds. Transparency and clear communication limited asymmetric information and supported predictability, while maintaining margins of flexibility to allow central banks to adjust the pace, timing or volume of purchases in response to changes in prevailing market conditions. Finally, central banks adopted measures to alleviate scarcity effects, such as securities lending programmes.

As experience with expiring lending programmes and shrinking balance sheets has been more limited, conclusions regarding the impact on market functioning are more tentative. However, preliminary evidence suggests that steps can be taken to mitigate any negative side effects from the expiry of lending programmes (such as bank fragility), and cutbacks in securities holdings (such as diminished trading and inventory capacity among securities dealers), including by adhering to the general principles of gradualism and predictability."



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Added note: The Financial Times published this article quoting the BIS as saying that the central bank stimulus programs have produced "negative side effects". The FT titled their article:


The introductory paragraph to the FT article says that "the unprecedented growth in central banks' balance sheets since the financial crisis has had a negative impact on the way in which financial markets function, according to a new report from the Bank for International Settlements."


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