Unconventional-Monetary-Policy | Macro Paper Warehouse

Central Bank Independence at Low Interest Rates

Mon, 01 Jan 0001 00:00:00 +0000

This paper constructs a new measure of political pressure on the Federal Reserve from textual analysis of Fed Chairs’ testimonies at Humphrey-Hawkins congressional hearings, and documents that the use of non-traditional monetary policy instruments at the effective lower bound (ELB) led to increased political criticism that predicts legislative actions threatening central bank independence. A model is developed in which the probability of the monetary authority’s future loss of independence is increasing in the use of non-traditional instruments, leading to attenuated monetary responses and higher inflation volatility. The attenuation can be mitigated under an institutional framework with clearly defined targets where the central bank is evaluated by how efficiently it achieves its goals.

Summary based on a working paper version, AI-assisted and human-reviewed. See the linked published article for the authoritative version.

In depth

Q1. What is the new measure of political pressure and what does it capture?

The paper constructs a measure of political pressure on the Federal Reserve by analyzing the evolution of critical questions and statements directed at Fed Chairs during semi-annual Humphrey-Hawkins Act testimonies to Congress, and finds that the number of critical statements specifically referencing non-traditional instruments increased significantly following the 2008 financial crisis. The measure tracks not only the volume of criticism but also its content—distinguishing criticism that specifically references the ELB tools from general discontent associated with low interest rate environments—allowing the paper to isolate the effect of unconventional policy use from other factors associated with the ELB subsample.

Q2. What is the empirical link between political criticism and legislative threats?

Following Hess and Shelton (2016), the paper analyzes bills introduced to Congress that threaten the powers of the Federal Reserve, and finds that the new measure of congressional criticism correlates highly with the introduction of such threatening legislation; moreover, the number of threatening bills specifically mentioning unconventional monetary policy is predicted by the amount of criticism referencing new policy tools. This provides an empirical chain from the use of non-traditional tools to political blowback to concrete legislative risk to Fed independence, motivating the theoretical model.

Q3. How does the threat to independence affect monetary policy in the model?

In the model, when the probability of future loss of independence is increasing in the use of non-traditional instruments, the optimal monetary authority chooses attenuated responses—using non-traditional tools less aggressively than the unconstrained inflation-minimizing policy would prescribe—thereby generating higher inflation volatility as a consequence of the political risk. The model captures the democratic reality that a central bank’s independence is inherently revocable by the legislature; a central bank that interprets congressional criticism as a credible signal of independence risk will internalize this constraint in its policy decisions.

Q4. How can institutional design mitigate the attenuation?

An institutional framework with clearly defined targets where the central bank is evaluated by how efficiently it achieves its goals—rather than by discretionary judgments about the appropriateness of its tools—mitigates the attenuation of monetary responses by narrowing the scope for politically motivated criticism of non-traditional instruments. If critics must evaluate the central bank against transparent targets, they face a higher evidentiary bar for threatening its independence when non-traditional tools are being used to meet those targets; this reduces the political risk of using such tools and restores the unconstrained optimal policy.

Key concepts

Humphrey-Hawkins testimony measure : the paper’s text-based measure of political pressure on the Fed, constructed from the volume and content of critical questions and statements directed at Fed Chairs during semi-annual congressional testimonies; found to predict threatening legislative actions. attenuation of monetary responses : the reduction in the aggressiveness of non-traditional monetary policy use relative to the unconstrained optimal policy, arising from the central bank’s internalization of the political risk of independence loss associated with using non-traditional instruments. clearly defined institutional targets : an institutional framework in which the central bank’s mandate is operationalized as specific measurable targets and the bank is evaluated by its efficiency in achieving them; shown here to mitigate the political risk of non-traditional instruments and restore optimal monetary responses.

Credit Easing versus Quantitative Easing: Evidence from Corporate and Government Bond Purchase Programs

Mon, 01 Jan 0001 00:00:00 +0000

Using security-level data on individual corporate bond prices and the Bank of England’s published purchase quantities across its gilt purchase programs (QE1: £200bn, QE2: £125bn, QE3: £50bn, QE4: £60bn) and Corporate Bond Purchase Scheme (CBPS: £10bn of investment-grade sterling corporate bonds), this paper estimates supply effects of QE and CE on UK corporate bond prices, credit spreads, and new issuance separately, exploiting cross-sectional variation in quantities purchased as identifying variation via an instrumental variables approach. In the case of QE alone, supply effects on corporate bond prices are significant at announcement and larger over the full stock-effect horizon, but pass-through to credit spreads is found to be limited to the default-free component of corporate yields under normal market conditions — an exception is QE1 during the financial crisis, when QE’s cross-asset supply effects also significantly lowered credit spreads in the longer run. CE via the CBPS is found to be more effective than QE in reducing credit spreads for higher-rated investment-grade bonds even under normal conditions, and is the only program that generates a statistically significant increase in sterling corporate bond issuance. The results are consistent with QE and CE working through partially distinct channels — QE primarily affecting the default-free component of corporate yields, CE additionally compressing the credit-spread component — and complementing each other for higher-rated bonds.

Summary of a forthcoming paper, AI-assisted and human-reviewed. See the linked original for the authoritative claims and full conditions.

In depth

Q1. What is the empirical strategy and why use a security-level approach?

The paper uses a two-stage instrumental variables (IV) approach at the individual corporate bond level, with pre-program bond characteristics — maturity, yield-curve fitting errors, the BoE’s prior ownership share in the gilt bucket — serving as instruments for the expected distribution of purchases across bonds, allowing isolation of the supply channel from signaling and duration channels. The security-level approach offers three advantages over aggregate or event-study methods: it enables construction of “substitute buckets” (bonds whose maturity is close to the purchased bonds’) to estimate cross-asset supply effects; it permits direct comparison of the price elasticity with respect to gilt purchases (cross-asset effect) versus corporate bond purchases (within-asset effect); and it allows estimation of both the announcement-day effect and the stock effect — the cumulative price and spread change over the life of each program — which captures the longer-run portfolio-rebalancing contribution separately from the initial market reaction.

Q2. What are QE’s effects on corporate bond prices and credit spreads?

For QE alone (QE1–3), the instrumented gilt substitute purchases have positive and statistically significant effects on corporate bond prices at announcement across all three programs — in the case of QE1, the average 30 basis-point decline in corporate yields on the announcement day is attributed in full to QE supply effects in the paper’s regression. The stock effect — estimated over the full life of each program — is significantly larger than the announcement-day effect, consistent with gradual portfolio rebalancing as predicted by Greenwood, Hanson, and Liao (2018). However, except for QE1, the supply effects do not carry through to credit spreads in either the short run or the longer run, which the paper interprets as consistent with QE working primarily through the default-free component of the corporate yield: corporate yields fell in line with gilt yields, but spreads over gilts were unchanged.

Q3. When does QE affect credit spreads?

QE1’s cross-asset supply effects significantly lowered credit spreads in the longer run, even though QE2 and QE3 do not generate significant credit spread compression in either the short or long run, suggesting that the supply channel interacts with the liquidity channel specifically under conditions of financial market distress. The paper interprets the QE1 exception as reflecting the severe disruption during the 2008–09 financial crisis: when capital mobility across markets is constrained and liquidity premia are elevated, central bank purchases of safe assets may also improve trading conditions in indirectly targeted, less liquid markets such as the corporate bond market, reducing the liquidity component of corporate spreads. This interaction does not appear to be operative in the more normal market conditions of QE2 and QE3.

Q4. How does CE compare to QE in reducing credit spreads and stimulating issuance?

CE via the CBPS is found to be more effective than QE in reducing credit spreads for higher-rated investment-grade bonds even under normal financial market conditions, and a corporate bond’s price sensitivity to its own CBPS purchases is substantially higher than its price sensitivity to gilt substitute purchases; CE is also the only program with a statistically significant positive effect on new sterling corporate bond issuance. Across QE1–3, there is no statistically significant impact of gilt purchases on sterling corporate issuance, while CBPS purchases have positive and statistically significant effects on new sterling corporate bond issuance. The paper characterizes CE and QE as complementary for higher-rated bonds: CE’s credit-spread reduction layers on top of QE’s default-free component effect, making the total stock effect larger than either program alone.

Q5. What happens for lower-rated investment-grade bonds?

For lower-rated investment-grade bonds, the evidence for both cross-asset QE supply effects and within-asset CE supply effects is weaker, and the paper suggests that CE’s stimulation of new bond issuance may have counterbalanced its positive price effects for these bonds through the dilutive effect of new supply. The mechanism is that CE’s reduction in the cost of corporate bond issuance for lower-rated firms induced enough new bond issuance to partially offset the price increase from CBPS purchases, consistent with the issuance channel being most active for the market segment where CBPS created the largest pricing improvement. This dilution effect implies that the net price benefit of CE for lower-rated bonds is smaller than the gross supply-effect estimate.

Key concepts

stock effect : the cumulative effect of the total quantity of bonds purchased under a program on bond prices and spreads, estimated over the full life of the program; in this paper the stock effect is significantly larger than the announcement-day effect, consistent with gradual portfolio rebalancing.

cross-asset supply effect : the pass-through of government bond (gilt) purchase supply shocks to the prices of corporate bonds — an asset class not directly targeted by QE; the paper provides the first estimates of this cross-market supply channel at the security level.

credit spread : the difference between the yield on a corporate bond and the yield on a risk-free government bond of the same maturity; the paper finds QE pass-through is generally limited to the default-free component of corporate yields rather than the credit spread.

default-free component : the part of a corporate bond’s yield attributable to the risk-free interest rate rather than credit risk; the paper finds that QE supply shocks affect this component but generally leave the credit spread unchanged in normal market conditions.

within-asset substitution effect : the price effect of CE purchases on the bonds directly purchased and their corporate bond substitutes, as distinct from cross-asset effects; the paper finds this effect is substantially larger in magnitude than the cross-asset QE effect on corporate bonds.

issuance channel : the mechanism by which lower corporate borrowing costs induced by CE stimulate new corporate bond issuance; the paper finds this channel operates under CE (CBPS) but not under QE (gilt purchases).

Passive Quantitative Easing: Bond Supply Effects through Lower Debt Issuance

Mon, 01 Jan 0001 00:00:00 +0000

The paper introduces the concept of “passive quantitative easing” (passive QE): a deliberate reduction in government debt issuance that lowers anticipated future bond supply and reduces long-term yields through the same supply channel as central bank asset purchases, without involving asset purchases or reserves creation. The authors develop a unified classification scheme for central bank balance sheet policies organized by their net effect on anticipated future bond supply, and show that the Danish government’s unexpected January 2015 debt halt — which removed approximately 29.9 billion DKK from the outstanding bond stock over roughly nine months — was followed by a two-day yield decline of approximately 25 basis points across the entire yield curve. Regression estimates controlling for concurrent ECB and SNB actions imply that the halt raised the safety premium on Danish bonds by 17–22 basis points and reduced the ten-year term premium by 37–70 basis points, with combined effects pointing to 54–92 basis points in lower yields relative to the counterfactual. The Danish episode ranks approximately on par with the Federal Reserve’s QE3 in the classification scheme, and the paper argues that passive QT — unexpectedly higher debt issuance — is contractionary through two additional portfolio balance channels not present in active QT and should be treated as an active policy tool rather than a neutral background condition.

Summary of a forthcoming paper, AI-assisted and human-reviewed. See the linked original for the authoritative claims and full conditions.

In depth

Q1. What is “passive QE” and what distinguishes it from conventional QE?

The paper defines passive QE as a reduction in government debt issuance that lowers anticipated future bond supply, arguing this is functionally equivalent to central bank asset purchases in its effects on long-term yields, even though it involves neither asset purchases nor reserves creation. The supply-side equivalence holds because what matters for term premia and safe-asset premia is the anticipated future stock of bonds available to private investors: whether the central bank withdraws bonds via outright purchases or the government simply issues fewer new ones, the anticipated future supply declines, requiring downward adjustment in the compensation investors demand for duration risk and scarcity. The distinction from active QE is therefore operational rather than economic: passive QE leaves the central bank’s balance sheet unchanged, makes no reserve injection, and requires no fiscal–monetary coordination beyond the government’s own debt management decisions.

Q2. How do the authors classify central bank balance sheet policies?

The paper proposes a unified classification scheme that maps central bank balance sheet policies by their net effect on anticipated future bond supply, placing passive QE in the same stimulative category as active QE programs and ranking the Danish halt at approximately −0.0104 on this measure — nearly on par with the Federal Reserve’s QE3 at −0.0120. The scheme allows cross-country and cross-program comparisons of unconventional monetary policy actions by reducing them to a common currency of anticipated supply change. The classification also distinguishes passive QT from active QT: the paper argues that passive QT (higher-than-anticipated issuance) is more contractionary than active QT of equal magnitude because higher issuance also reduces safe-asset scarcity value and shifts duration risk back to the market through two additional portfolio balance channels.

Q3. What does the Danish debt halt episode show?

The January 30, 2015 announcement by Denmark’s debt management office that it would halt new government bond issuance for the remainder of the year was unexpected and was followed within two trading days by a yield decline of approximately 25 basis points across the entire yield curve. The halt lasted roughly nine months and reduced the outstanding Danish government bond stock by approximately 29.9 billion DKK. The reaction is interpreted as evidence that market participants immediately revised down their expectations of future bond supply, compressing the compensation required for holding duration risk and raising the relative value of the now-scarcer safe assets.

Q4. What do the regression estimates imply?

Controlling for the concurrent SNB and ECB announcements in January 2015, the authors’ regression estimates imply that the Danish halt raised the safety premium on Danish bonds by 17–22 basis points and reduced the ten-year term premium by 37–70 basis points, pointing to a combined reduction in bond yields of 54–92 basis points relative to the counterfactual without the halt, measured over the halt period. The term-premium decline is interpreted as consistent with supply-induced portfolio balance effects: fewer bonds requiring lower duration-risk compensation. The safety-premium increase is consistent with safe-asset scarcity effects: a tighter supply of high-quality government bonds raising their relative scarcity value. These two channels are identified separately in the yield decomposition and estimated to be independently significant.

Q5. How does the paper treat passive QT?

The paper argues that passive QT — a higher-than-anticipated level of government debt issuance — is not a neutral background condition but an active contractionary force, and potentially more contractionary than active QT of equal magnitude through two additional portfolio balance channels. The argument is that higher issuance reduces safe-asset scarcity value and directly shifts duration risk from the central bank to the market, while active QT (central bank balance sheet reduction) lacks these two additional channels. This implies that fiscal authorities’ debt issuance decisions carry monetary policy implications that are not captured in frameworks treating issuance as a non-monetary decision.

Key concepts

passive QE : a deliberate reduction in government debt issuance that lowers anticipated future bond supply and reduces long-term yields through supply effects; the paper treats it as functionally equivalent to central bank asset purchase programs despite involving no asset purchases or reserves creation.

passive QT : higher-than-anticipated government debt issuance; the paper treats it as an active contractionary tool, potentially more contractionary than active QT of equal magnitude, because it triggers two additional portfolio balance channels.

safety premium : the premium on high-quality safe assets such as government bonds reflecting their scarcity value; in the Danish halt episode this rose as supply tightened.

term premium : the component of a long-term bond yield compensating investors for bearing duration risk; in the Danish halt episode this fell as anticipated future bond supply declined.

classification scheme : the paper’s taxonomy of central bank balance sheet policies organized by their net effect on anticipated future bond supply, allowing cross-program comparisons including passive QE and passive QT.

Danish debt halt : the January 30, 2015 announcement by Denmark’s debt management office of a halt to new government bond issuance for the remainder of the year, used as the natural experiment to test the passive QE hypothesis.