Or, more evidence that the Federal Reserve’s unconventional monetary policy affects everything.
In a new St Louis Fed working paper, Christopher J. Neely makes a case for the international effects of the Fed’s large-scale asset purchases (LSAPs). That’s the quantitative/credit easing, which saw the US central bank snap up agency debt, mortgage-backed securities and long-term US Treasuries.
The Fed began its purchases in late 2008, in an effort to directly target asset prices, and specifically, flatten the yield curve and bring down long-term rates. It also has the added-bonus of being currency depreciative. And, though the Fed may have been targeting American assets in its open market ops, this paper suggests just the announcements of the LSAP moves had some very international impacts.
Specifically, it finds that:
The LSAP purchase announcements generally strongly reduced the long (10-year) rates of Canada, Germany, Japan, and the United Kingdom and they also depreciated the USD versus the currencies of those countries. The observed effects of the purchases on international bond yields are consistent with calculations from a simple portfolio choice model. Likewise, the changes in exchange rates at the time of the announcements are approximately consistent with an “overshooting” effect produced by UIP and purchasing power parity (PPP). The overall results strongly indicate that the LSAP program had sizeable effects on international bond yields and exchange rates. These effects might have had some stimulative impact on the U.S. economy through export channels, though a study of those effects is beyond the scope of this paper.
In fact, every announcement of LSAP generated something like a 45 basis point decline in foreign bond yields — that’s Canada, Germany, Japan and the UK — over a two-day window. Stripping out Japan’s already very low-yielding (and QEased) bonds, LSAP statements would have led to an average drop of about 60bps. Those are movements too large, the paper says, to have occured just by chance.
What to make of that action?
Neely doesn’t find (if if this is what you might have been thinking) that the declines occured simply because purchase announcements were interpreted by the market as signs of weaker future growth. Instead the paper suggest the action can be attributed to portfolio balancing. (More on that here).
The conclusion:
The success of the LSAP in reducing long-term interest rates and the value of the dollar shows that central banks are not toothless when short rates hit the zero bound. Contrary to long and widely held conventional wisdom, large asset purchases can affect long rates, both domestically and abroad. Monetary policy’s effect at the zero bound includes international channels. The reduction in foreign bond yields and the value of the USD might have stimulated the U.S. economy through export channels, for example. From an international perspective, study of the LSAP effects implies that central banks should coordinate their asset purchase policies to avoid contradictory or overly stimulative effects.
Easier said than done, of course.
(A much wonkier discussion of the paper available in the first link below).
Related links:
The return of portfolio balance models… - Econbrowser
The Fed’s last QE experiment… – FT Alphaville
Gotcha! QE and devaluation – FT Alphaville
FOREIGNERS ARE STEALING OUR QUANTITATIVE EASING – FT Alphaville