European Finance Association
Milan, Italy | August 25-27, 2021
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APE 12: Monetary Policy and Asset Prices
Unbundling Quantitative Easing: Taking a Cue from Treasury Auctions
1London School of Economics; 2UC Berkeley; 3Harvard University
We study empirically and theoretically the role of preferred habitat in understanding the economic effects of the Federal Reserve’s quantitative easing (QE) purchases. Using high-frequency identification and exploiting the structure of the primary market for U.S. Treasuries, we isolate demand shocks that are transmitted solely through preferred habitat channels, but otherwise mimic QE shocks. We document large "localized" yield curve effects when financial markets are disrupted. Our calibrated model, which embeds a preferred habitat model in a standard New Keynesian framework, can largely account for the observed financial effects of QE. We find that QE is modestly stimulative for output and inflation, but alternative policy designs can generate stronger effects.
Monetary Policy Expectation Errors
1Danmarks Nationalbank, Denmark; 2Bank for International Settlements; 3Goethe University Frankfurt; 4CEPR
We use survey data on expectations about future monetary policy to decompose excess returns to fed funds (FF) futures and overnight index swaps (OIS) into a term premium and an expectation error component. We find that excess returns are almost entirely driven by expectation errors, while term premia are slightly negative and economically small. We show that most of expectation errors stem from market participants underestimating how aggressively the Federal Reserve has eased policy during the last three decades. Our findings suggest that market participants are learning about the reaction function in an environment of uncertainty and have been slow to reflect a rising importance paid by the Fed to deteriorating financial conditions and falling stock market returns. We confirm our main results in an international sample of six major currencies.
Quantitative Easing and the Safe Asset Illusion
1University of St.Gallen, Switzerland; 2European Central Bank
The massive recourse to quantitative easing (QE) calls for a better understanding of its effects on safe assets. Based on a simple balance sheet framework, we show how QE impacts the total amount, cross-sectional distribution, and composition of safe assets in the economy. Analyzing the ECB's Public Sector Purchase Programme (PSPP), we find that the amount of universally accessible safe assets decreases and there is a transfer of safe assets from the non-bank to the banking sector. We call this phenomenon the safe asset illusion. The sectoral shift in the holding structure of safe assets has important implications for financial stability and the cost of secured liquidity.
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