Unconventional monetary policies revisited (Part I)

Biagio Bossone

04 October 2013



The 2007 financial crisis and the following economic slump led central banks in advanced economies to undertake unconventional monetary policies.1 The crisis evolution, especially in debt-ridden European nations, and the limits of the unconventional approaches adopted, triggered proposals for new heterodox responses. Below is a discussion of the unconventional measures implemented and the major proposals submitted. Key pointers will be discussed in Part II of this commentary.

Making money easier and cheaper: Quantitative and credit easing

As the crisis erupted, major central banks intervened to fix the broken financial markets by starting quantitative easing (QE). They committed to issuing liquidity by purchasing assets (including toxic) from banks and nonbanks, at a time when banks stopped lending to each other, households and firms were credit squeezed, and policy rates were running against the zero lower bound.2

When the crisis spilled over to the real sector, the objective of QE in some countries shifted from financial markets repair to revamping economic activity (“a step into the dark”, as Rajan (2013) dubbed it). In the US, UK, and Japan, QE turned at stimulating demand by lowering the cost of money and by raising inflation expectations (Bank of England 2011).

QE has been crucial to avert financial meltdown, and has had some effects on the macroeconomy (see, for instance, Joice et al. 2011, Gambacorta et al. 2012, and Cúrdia and Ferrero 2013). Yet there are reasons to be critical about its effectiveness for macroeconomic stabilisation relative to its costs and risks. QE has dramatically increased base money, but not the money supply that drives aggregate demand. QE injects money to owners of assets (e.g., traders, hedge funds, investors, banks, high-wealth individuals, and speculators) who benefit from QE-stirred bond and asset-price rises, but represent a tiny minority with a low propensity to consume. Conversely, QE does not reach common people (with higher propensity to consume) and deprives them of interest incomes: with given or falling incomes, and prices expected to rise, they may even reduce consumption.3 Although research on this issue is warranted, indications are that QE has significant distributional effects.4

Under QE, share prices rise and business cash holdings grow. Larger companies have used QE money to buy their own assets – through share buy-backs and debt-equity swaps, with little effects on output and employment. Smaller companies, with limited access to capital markets, have still had hard times borrowing from banks.

Where QE flattens the yield curve, risk pricing becomes distorted. Capital gets directed to otherwise unproductive and unprofitable uses. Money growth feeds bond and asset-price bubbles, and high-risk structured financial instruments re-emerge (Stein 2013 and IMF 2013). Voices of exit from QE increase interest rates and uncertainty (Grenville 2013 and Rajan 2013).

A major factor conditioning the macroeconomic effects of QE is its interaction with fiscal policy. Pulling QE alongside a restrictive fiscal policy is like pushing on the car’s accelerator and brake pedals at the same time, which is what has happened in the US and UK. The alternative is what Japan is doing under Abenomics, providing for a simultaneous expansionary use of the monetary and fiscal levers. But how is such a mix eventually going to play in an economy that is already plagued by a huge public debt? And what are the implications for central-bank independence?

Steering market expectations through forward guidance

Although conceived earlier than QE, at least in its original understanding, what has recently come to be known as forward guidance (FG) has evolved as a natural complement to QE, and has gained prominence among central banks as a way to influence market expectations on future interest-rate levels.5 When the central bank is constrained by the zero lower bound in its capacity to reduce the short-term rate, it can use FG to communicate its intention to keep the policy rate at the current level for some time in the future, even beyond the point when normalising it would be in order. Thus, FG implies a willingness to tolerate higher future inflation,6 and helps engineer an easing of credit conditions even at a constant short-term interest rate (Praet 2011). Importantly, FG marks the heightened attention from the monetary authorities to the level of economic activity and resource employment. It is expected that FG help central banks better explore the scope for economic expansion without jeopardising price and financial stability.

On the critical side: first, research has found only partial evidence that FG improves market participants’ ability to forecast short-term rates, and shows no evidence that it has increased monetary-policy efficacy in New Zealand, the country with the longest history of FG (see Kool and Thornton 2012). Second, it appears that standard central banks’ macroeconomic models tend to grossly overestimate the impact of FG on the macroeconomy – a phenomenon called the 'forward guidance puzzle'.7 Third, it is not clear what makes FG credible: what ensures the commitment underpinning it: will central-bank governors stick to the explicit promise or will they renege on it, when the time comes, by saying that long-term expectations have become less well anchored? (See Rajan 2013, and Clarida 2012). Finally, while preserving central-bank independence, FG does not resolve monetary-policy impotency at the zero lower bound.

The world beneath zero: Running negative interest rates

When the economy is in deep recession, liquidity preference keeps interest rates high, and policy rates run proximate to zero, the lower bound could be removed by allowing interest rates to go negative. Negative interest rates would apply to central-bank reserves, and possibly to bank deposits and other saving instruments. Cash would have to be suppressed or taxed (stamped), or a new currency would have to replace the one in circulation at a depreciated exchange rate vis-à-vis the unit of account, say, the dollar, which would remain the numéraire. NIR aims to make money such a 'hot potato' that banks and people should want to get rid of it: the former by lending it, the latter by spending it.

Mankiw (2009) resurrected the idea publicly, and Buiter (2009a,b) identified the above conditions for effective removal of the zero lower bound.8 The objections to negative rates are many (See for instance discussions by Coppola 2012, 2013, and the more analytical contributions by Garbade and McAndrews 2012, and by Van Suntum et al. 2011). Besides the odious idea of taxing money or of seemingly subsidising banks with negative rates on reserve lending, critics hold that negative rates negative rates would push people toward cash hoarding and safe asset accumulation, rather than spending. They argue that banks would still hold up lending if they perceived risks to be too high, and that their margins’ compression would lead them to charge higher, not lower, lending rates. Critics either ignore Buiter’s conditions or emphasise their practical hurdles. Kimball (2013b) points that the problem can be addressed by transferring legal tender from cash to electronic money, and proposes a detailed plan to do so.

While unconventional, negative rates do not involve central bank’s balance-sheet alterations, and does not infringe central-bank independence. It is not clear, however, if and what legal issues would be raised by its implementation.

Experience with negative rates is very limited. The central bank of Sweden charged a negative rate on its deposit facility as a response to the 2008 crisis, but without shifting the monetary-policy regime, and the central bank of Denmark introduced a negative rate on deposit certificates in 2012, only to lessen exchange rate pressures. In early 2013 the Bank of England has considered the possibility of a negative rate for macro stabilisation, and last June the ECB has indicated to be technically ready for it. Both central banks, however, have refrained from taking commitments.10

Overt money financing of fiscal deficits

The idea was revived by Bernanke (2003). He recommended that Japan fight deflation through public deficits explicitly financed with incremental – and permanent – central-bank purchases of government debt. The money created would finance tax cuts or new spending programmes. If the money had gone to finance tax cuts – Bernanke argued – consumers and businesses would likely spend their tax-cut receipts, since no current or future debt-service burden would be created to imply future taxes.11

Yes, but what about the debt implications of Overt money financing? The key element is the permanency of the purchases of public debt, which rules out that the new debt will ever be placed on the market.12 Permanency eliminates Ricardian equivalence effects, and prevents new debt accumulation,13 but raises government-central bank relationship issues, to be discussed in Part II.

Overt money financing comes as close as possible to putting money into the public’s hands for spending: it’s 'helicopter money'. More extreme forms are proposed by Wood, and by Cattaneo and Zibordi.14 They submit that in highly leveraged and depressed economies the minister of finance should be granted the power to issue a form of complementary money, with legal tender, to be used to finance fiscal deficits large enough to stimulate demand. The government would have full sovereignty on the issuance of the complementary money.15

Monetising the debt

Considering the public debts of some Eurozone countries as unsutainable, Pâris and Wyplosz (2013) propose that the ECB purchase and subsequently eliminate these debts through debt monetisation. In practice, the ECB would purchase the outstanding debt of a euro member in exchange for a zero-interest loan of an equal amount. The loan would stay indefinitely on the ECB books, and will never be repaid. Notice that, like in the case of overt monetary financing, the monetisation would be permanent. The counterpart of the operation would be an equal supply of euro monetary base, which would represent the cost of monetisation. The monetisation would be a one-off measure, and would not be intended directly at supporting economic activity; yet it would regain fiscal space to the government and spending capacity to the economy. The inflation risk would be remote, according to the monetisation proponents, due to the weak economic conditions of the countries considered but, if necessary, the ECB could sterilise the money issued. The proposal does not deal with the institutional issues underpinning monetisation in a context of a multi-national setting with a strongly independent central bank.

This review above points to a number of considerations. I discuss these in the second of this two part series to be posted tomorrow.


Bank of England (2011). “Quantitative easing explained: putting more money into our economy to boost spending”, London: Bank of England.

Bank of England (2012), “The distributional effects of asset purchases”, 12 July.

Bernanke, B (2003), “Some thoughts on monetary policy in Japan”, Tokyo, Remarks by Governor Ben S Bernanke Before the Japan Society of Monetary Economics, Tokyo, May 31.

Binder, C (2013), “What does Abenomics feel like?", Quantitative Ease, August 19.

Borio, C and P Disyatat (2009), “Unconventional monetary policies: an appraisal”, BIS Working Papers, No 292, Bank for International Settlements, November.

Bossone, B and R Wood (2013), “Overt money financing of fiscal deficits: navigating Article 123 of the Lisbon Treaty”, EconoMonitor, July 22nd.

Buiter, Willem H (2004), “Helicopter money: irredeemable fiat Money and the liquidity trap”, CEPR Discussion Papers 4202, January.

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Buiter, W (2009b), “The wonderful world of negative nominal interest rates, again”, VoxEU.org, 4 June.

Carlson J, J G Haubrich, K Cherny, and S Wakefield (2013), “Credit easing: a policy for a time of financial crisis”, Economic Trends, Federal Reserve Bank of Cleveland, 11 February.

Cattaneo, M and G Zibordi (2013), “Una soluzione per l’euro: gli strumenti per rimettere in moto l'economia italiana”, Hoepli Editore, forthcoming

Clarida, R. H. (2012), “What has—and has not—been learned about monetary policy in a low-inflation environment? A review of the 2000s”, Journal of Money, Credit and Banking, February, pp. 123–140

Coppola, F (2012), “The strange world of negative interest rates”. Coppola Comment, 12 December.

Coppola, F (2013), “The problem of cash”, Coppola Comment, 12 January.

Cúrdia, V and A Ferrero (2013), “How stimulatory are large-scale asset purchases?, FRBSF Economic Letter 2013-22, Federal Reserve Bank of San Francisco, 12 August.

Dale, S and J Talbot (2013), “Forward guidance in the UK”, VoxEU.org, 13 September.

Del Negro M, M Giannoni and C Patterson (2013), “The forward guidance puzzle”, Federal Reserve Bank of New York Staff Papers Number 574.

DeLong, B (2009), “Silvio Gesell and stamped money: another thing Fisher and Wicksell knew that modern economists have forgotten”, Brad DeLong, 18 April.

Eggertsson, G B and M Woodford (2003), “Optimal monetary policy in a liquidity trap”, NBER Working Papers 9968, National Bureau of Economic Research, Inc.

Fawley, B W and C J Neely (2013), “Four stories of Quantitative Easing”, Federal Reserve Bank of St. Louis Review, January/February, 95(1), pp. 51-88.

Gambacorta L, B Hofmann, and G Peersman (2012), “The effectiveness of unconventional monetary policy at the Zero Lower Bound: a cross-country analysis”, BIS Working Papers No 384, Bank for International Settlements, August.

Garbade, K and J McAndrews (2012), “If interest rates go negative…or , be careful what you wish for”, Federal Reserve Bank of New York, 29 August.

Grenville, S (2013), “Unwinding quantitative easing”, VoxEU.org, 22 June.

IMF (2009), “Unconventional choices for unconventional times: Credit and Quantitative Easing in advanced economies”, Staff Position Note, SPN/09/27, prepared by the Research and Monetary and Capital Markets Departments (V. Klyuev, P. de Imus, and K. Srinivasan), 4 November.

IMF (2013a), “Global Financial Stability Report: Old Risks, New Challenges”, World Economic Financial Surveys, International Monetary Fund, April 2013.

IMF (2013b), “United Kingdom—2013 Article IV Consultation Concluding Statement of the Mission", 22 May.

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Kimball, M (2013b), “The path to electronic money as a monetary system”. Confession of a Supply-Side Liberal, 5 September.

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1  See IMF (2009). Although several taxonomies have been employed in the literature to discuss unconventional monetary policies (Stone et al 2011), all of them refer to their characterisation as “balance sheet” policies, introduced by Borio and Disyatat (2009) in the first systematic review of the issue, whereby the central bank actively uses its balance sheet to affect directly market prices and conditions beyond a short-term, typically overnight, interest rate. In contrast to the traditional interest rate policy, unconventional monetary policies result in substantial changes in the central-bank balance sheet, in terms of size, composition and risk profile, as they target market segments that go beyond that for bank reserves and over which the central bank has far less control.

2 Still in early 2000, referring to the complex of unconventional monetary policy tools that had been introduced in the US, Federal Reserve chairman Ben Bernanke spoke of “credit easing”, to distinguish the approach followed by the Fed from the“quantitative easing” adopted by the Bank of Japan during 2001-2006. Whereas the latter had aimed at increasing the quantity of money to support prices and improve economic activity, the former aimed at changing the asset composition of the central bank’s balance sheet in order to facilitate credit access to financial and non financial institutions under stress (Carlson et al 2009). In Europe, the ECB initially focused on meaures to enhance interbank and nonbank credit market conditions; subsequently, it introduced instruments to purchase government debts in the secondary markets with a view to addressing the malfunctioning of securities markets, and to restoring an appropriate monetary policy transmission mechanism. For a detailed recounting of QE operations in Europe, Japan, UK, and the US, see Fawley and Neely (2013). Central banks in emerging market economies have not engaged in unconventional policy since they were not confonted with deflationary trends. Exceptions were the central bank of Turkey, where monetary policy has aimed at managing at capital flows and credit controls were used to check inflation, and the central bank of Brazil, which has intervened in FX futures markets to counteract speculative activity on exchange rates. I am grateful to Otaviano Canuto for sharing information on monetary policies on emerging-market countries.

3 See, for instance, the result of the Bank of Japan’s public expectations survey http://www.boj.or.jp/en/research/o_survey/ishiki1308.pdf, and the comment by Binder, 2013.

4 The Bank of England (2012 points that the overall impact of QE on household wealth – by pushing up asset prices – is likely to be substantial, but notes that the benefits from wealth effects accrue to those households holding most financial assets, and that financial asset holdings are heavily skewed with the top 5% of households holding 40% of the assets and with the median household holding only around £1,500 of gross assets.

5 Krugman (1998) and Woodford originated the line of thinking underpinning FG, which was later further developed by Eggertsson and Woodford (2003). As was the case with inflation targeting, the Reserve Bank of New Zealand was the first central bank to adopt FG. In 1997 it started announcing a path for the three-month bank bill rate.

6 This stands out quite clearly in the illustration of FG in the UK, by Dale and Talbot (2013).

7 Del Negro et al. (2013), who have coined this expression, show that, as long as FG extends far into the future, the modelled impulse response to the extended peg will lift the short-term rate in the previous period, thus requiring a cascade of shocks over that period in order to push the interest rate back down. As a result of this feedback-loop mechanism built into the models, even a modest amount of FG is predicted to produce unrealistically large real effects.

8 Buiter and Panigirtzoglou had already discussed NIR in the early 2000s (see http://ideas.repec.org/e/pbu137.html). The idea goes back to the original proposal by the (unduly neglected) German businessman and economist Silvio Gesell (see DeLong (2009), and Kimball (2013a)). The idea was successfully experimented with in the Austrian city of Woergl in the 1930s. It is to be noticed, however, that negative rates were applied only after a new complementary currency was issued by the city authorities and used to finance public spending programmes (see http://www.reinventingmoney.com/documents/worgl.html). The Woergl experiment resembles closely the overt monetary financing of fiscal deficits discussed below.

9 See “Negative interest rates: the Danish experience”, Nordea Research, April 2013 (http://research.nordeamarkets.com/en/files/negative-rates-April13.pdf)

10 See official communications, respectively, at http://www.bankofengland.co.uk/publications/Documents/other/treasurycomm..., and http://www.ecb.europa.eu/press/pressconf/2013/html/is130606.en.html). On the ECB’s thinking about negative rates, see Nowakowski (2012).

11 McCulley and Pozsar (2013) and Adair Turner (2013) review the combined use of monetary and fiscal policies in a deleveraging context, and conclude that OMF provide the most effective way to address deflationary conditions.

12 In studying an economy with a consolidated fiscal and monetary authorities, Buiter (2004) indicates that the increase in the nominal stock of money must be permanent for it to have positive real effects. In the case of OMF, as these are run by separate and independent authorities, the condition of permanency must be extended to cover the central bank’s purchases of public debt.

13 In fact, with no repayment obligation, deficits financed with OMF do not even constitute debt, but fiat money allocation from the State to itself. Bossone and Wood (2013) discuss this issue and its implication for central bank finances.

14 See Wood (2012a,b,c), and Wood (2013). In a forthcoming book, Cattaneo and Zibordi (2013) submit a proposal for Italy, which could well be adopted by other eurozone countries currently in deep recession; see also http://bastaconleurocrisi.blogspot.it/2013/09/tax-credit-certificates-ce.... All these proposals can be theoretically situated within the Neo Chartalist school (see Wray (2000), and Tcherneva (2007)).

15 Interestingly, these proposals have an historical antecedent in the special government bonds that Germany issued in the 1930s, under central banker and finance minister Hjalmar Schacht, to survive the Great Depression as the country was heavily indebted and finally vexed by the winning power of the First World War. The operation succeeded in pushing the German economy through a speedy recovery.



Topics:  Monetary policy

Tags:  monetary policy, QE, helicopter money

Chairman, Group of Lecce; Member of the Surveillance Committee, Centre d'Études pour le Financement de Développement Local