Über-QE | FT Alphaville


We are going to call this über-quantitative easing, although someone else will surely come up with a suitably boring technical name for it in due course.

It is mentioned in a 32-page discussion note by RBC Capital Markets economist Russell Jones on the subject of QE.

The results of the unconventional monetary policy so far, the economist says, have been rather mixed. Jones has therefore turned his attention to what other policies central banks could pursue to stave off deflation — and he’s come up with the following (our emphasis):

If existing QE policies fail and today’s evidence of a burgeoning recovery proves to be a false dawn, this does not mean that monetary policy is exhausted. Central banks retain other options. First, central banks could, of course, announce a new and expanded programme of outright asset purchases, or even some sort of open ended commitment to continue to buy a significant quantity of bonds until there is sufficient evidence of a sustainable recovery. But another, and arguably more potent, option is to announce prescribed (lower) targets for a selection of longer term interest rates, as was done by the Fed in the 1940s and early 1950s. Indeed, this is an approach which Ben Bernanke appeared particularly disposed towards in his now famous “Deflation: Making Sure it Doesn’t Happen Here” speech, given back in November 2002 — a speech that has provided the template for much of the Fed’s strategy since this credit crisis began.

Such an approach would, in effect, equate to an unlimited pledge to purchase Treasury securities of the targeted maturities at a preannounced price. But it would also amount to the central bank formally indicating that it believed current market expectations of the future trajectory of policy rates were very much at variance with its own. One must ask, therefore, whether or not it is possible for a central bank actually to establish an alternative interest rate term structure without it in the end owning most, if not all, of the particular government securities it decides to target. Much would depend on the thrust of the Treasury’s debt management policies, and in particular the maturity profile of its issuance. But even if the tactic of targeting specific Treasury yields proved successful, there is a risk that those targets become detached from the rest of the term structure and/or from the yields prevailing on private sector securities.

Put simply, the über-QE policy involves targeting specific interest rates at different points on the Treasury yield curve. In the 1940s case, the Fed pegged 25-year Treasuries at 2.5 per cent, one-year Treasury bills at 7/8 of a per cent, and three-month T-bills at 3/8 of a per cent. This had the effect of keeping the rates relatively low, thereby encouraging spending and facilitating the US Treasury’s wartime debt refunding operations.

It differs from ‘traditional’ QE, which is more aimed at lowering longer-term interest rates via purchases of longer-term Treasuries. It is, we think, a more extreme manipulation of the yield curve — along the (attempted) lines of Operation Twist in the 1960s.

If all of that sounds too wonky for you, here’s another suggestion from RBC, which is much easier to understand:

But central banks retain further weapons still. They could, for example, directly underwrite further programmes of fiscal expansion (pure government debt monetisation, as was practised in Japan in the 1930s and recommended by Keynes) or seek to engineer negative interest rates by applying a specified time horizon to the value of legal tender, effectively taxing money balances. For example, a hundred dollar bill might have to be exchanged for a $90 bill after 12 months, meaning that the real interest rate on the currency was effectively -10%. Another variation on the theme of negative interest rates is to impose a penalty on the deposits that commercial banks hold at central banks, in an effort to encourage them to lend out the excess reserves they have accumulated. This particular strategy has already been embraced by the Swedish Riksbank.

Finally it should be stated that in extremis, there is no limit to the amount of money that central banks can create, or indeed what they can buy. They have a monopoly on the money printing process and could even buy physical assets to influence the overall supply/demand balance in an economy.

There. Feel better? If we don’t manage to prevent deflation via current unconventional monetary policy, central banks can, err, just buy everything.

Full RBC note, with some good philosophical debate, available in The Long Room.

Related links:
To twist a Treasury – FT Alphaville
Negative interest in cash, or goodbye banknotes – FT Alphaville