Unconventional monetary policies in the euro area, Japan, and the United Kingdom
Skip to main content Editor's Note:
This paper will be presented at the event, âUnconventional monetary policy: How well did it work?â on October 17, 2018.
Deputy Director - Research Department, International Monetary Fund
Deputy Division Chief - Research Department, International Monetary Fund
Senior Economist - Western Hemisphere Department, International Monetary Fund
In response to the global financial crisis of 2008, the central banks of the euro area, Japan, and the United Kingdom deployed a variety of unconventional monetary policies i n an effort to support distressed financial markets and slowing economies. In a new Hutchins Center Working Paper, a version of which is forthcoming in the Journal of Economic Perspectives, Giovanni DellâAriccia, Pau Rabanal, and Damiano Sandri of the International Monetary Fund examine the effects of negative interest rates, forward guidance, and large-scale asset purchases. They argue the policies helped relieve financial distress, lower long-term interest rates, and support economic activity in all three regions.
DellâAriccia and coauthors review a large body of evidence that both large-scale asset purchases and forward guidance substantially reduced yields on long-term government bonds in the euro area, Japan, and the U.K. Research on Japanâs experience with negative interest rates also suggests they were able to lower short-term yields when the Bank of Japanâs policy rate sat at zero. Studies in all three regions show that the policies reduced corporate bond yields, lifted equity prices, and depreciated local currencies, although these effects were milder in Japan. And although evidence of their direct effects on GDP and inflation is more limited, studies indicate both forward guidance and large-scale asset purchases had positive effects on output by reducing long-term interest rates.
The authors outline three key lessons learned from the European, Japanese, and British experiences:
First, both forward guidance and large asset purchases are especially effective during periods of financial distressâ"consistent with both market segmentation and uncertainty-based theories of why unconventional policies work. The Bank of Englandâs first round of asset purchases in 2009, for example, appear to have had larger effects than did purchases conducted after financial markets had stabilized.
Second, Japanâs experience demonstrates that unconventional policies are less effective when households and businesses have entr enched low-inflation expectations. The Bank of Japanâs forward guidance, for example, was largely ineffective, as firms and households already expected interest rates to remain near zero for some time prior to the launch of new policies.
Third, DellâAriccia and coauthors say central bank credibility is the key ingredient in effective policy; this was especially true for the European Central Bank and the Bank of England, where unconventional tools had never been used. In the euro area, for example, the European Central Bankâs (ECB) Long-Term Refinancing Operations in the early years of the crisis had little effect on lending rates and aggregate demand, as markets remained skeptical about the ECBâs authority or commitment to maintain the facility. The ECBâs major QE program, on the other hand, provided an open-ended and credible commitment to providing stimulus, and had much greater effects on sovereign bond yields. Still, the authors acknowledge that employing unconv entional tools encouraged skepticism and additional scrutiny of central banks that could put their independence at risk in the future.
Looking ahead, unconventional monetary policies could provide crucial relief in a future recession that pushes interest rates to the zero lower bound, the authors say. But existing toolsâ" quantitative easing and negative interest rates in particularâ"are limited in their effectiveness if inflation expectations become unanchored or the central bank cannot make credible commitments. Policymakers ought to consider how fiscal stimulus or monetary frameworks that reduce the likelihood of encountering the zero lower bound can complement unconventional monetary tools in the future.
Read the full paper here.
*Sage Belz and David Wessel contributed to this post.
A version of this paper will be published in the Fall 2018 issue of the Journal of Economic Perspectives, Volume 32, Number 4.
The authors did not receive financial support from any firm or person with a financial or political interest in this article. None is currently an officer, director, or board member of any organization with an interest in this article.Wed Oct 17 Upcoming Event
Unconventional monetary policy: How well did it work?- Washington, DC Up Front
Hutchins Roundup: Medicaidâs effects on financial health, exchange rates and unconventional monetary policy, and moreSage Belz, Finn Schuele, and Louise Sheiner
Report Produced by The Hutchins Center on Fiscal and Monetary Policy
- < /ul> International Financial Institutions
The first 20 years of the European Central Bank: Monetary policyPhilipp Hartmann and Frank Smets Future Development
Why US multilateral leadership was key to the global financial crisis responseDouglas A. Rediker Global Economy
10 years after the financial crisis: Uneven progress and some structural disconnectsKarim Foda and Eswar Prasad
Get updates on economics from BrookingsGet daily updates from Brookings CloseSource: Google News United Kingdom | Netizen 24 United Kingdom