By Ajai Chopra
Mervyn King, the Bank of England governor, once quipped that central bankers aim to keep monetary policy “boring”—a dull exercise in maintaining low and stable inflation. Recent months have seen quite the opposite.
Battling a sharp fall in inflation, central banks around the globe have slashed interest rates, often to close to zero. Several have also made headlines by adopting unconventional policies, including “quantitative easing” at the Bank of England (BoE) and “enhanced credit support” at the European Central Bank (ECB).
Are these unconventional strategies working? And what are the associated risks? Two new IMF studies address these questions.
ECB’s non-standard approach: uncharted waters
The ECB presents an unusual case. Its approach, unlike that of some other major central banks, has not involved outright purchases of sovereign debt. Instead, the ECB has used its standard framework, based on repurchase facilities. But within this framework it has employed nonstandard measures, including lengthening the maturity of these facilities and providing massive funds at fixed rates.
In the first study, Martin Čihák, Thomas Harjes, and Emil Stavrev analyze the ECB’s response to the financial crisis, using a combination of econometric approaches. They find that the ECB’s measures have been useful in reducing money market term spreads, facilitating the pass-through from policy to market rates. Moreover, the measures may have had favorable effects on government bond term spreads.
An important feature of the ECB’s interventions is that the repurchase facilities will unwind naturally as they mature. This offers a relatively straightforward exit path from the nonstandard measures.
Bank of England’s quantitative easing: no panacea, no curse
In the United Kingdom, the use of quantitative easing has triggered a controversial public debate. André Meier’s study analyzes the policy from a theoretical and empirical perspective.
He finds that quantitative easing has had some positive effects, by raising asset prices and near-term inflation expectations. However, the policy provides only limited direct support to private credit markets, and its overall impact is too early to judge. Quantitative easing is not a panacea. But it is an important addition to the Bank’s policy arsenal, and its expansion and change in emphasis on August 6 was appropriate.
Meanwhile, the policy has prompted fears that the BoE might lose its operational independence and that inflation might return with a vengeance. Reassuringly, the quantitative easing framework is designed to contain such risks through a robust set of safeguards:
- Full indemnity from the fiscal authority for possible capital losses (unique among major central banks)
- Continued control over policy rates through reserve remuneration
- Discretion to re-sell assets or issue central bank debt.
These safeguards should help the BoE exit from quantitative easing when appropriate. To be sure, timing the exit will be a difficult judgment call, and fiscal policy must do its part to maintain investor confidence. But quantitative easing clearly need not be a curse either.
Most likely, the policy will prove a useful extension of the BoE’s standard toolkit in today’s extraordinary circumstances—not all-powerful or entirely risk-free, but an important element in a set of policies to stabilize inflation and economic activity.
Longer term, the objective should be to restore boredom. Today’s unconventional measures will only be successful if they enable a return to the conventional.