Unconventional Monetary Policy

Quantitative Easing
QE is Large Scale Asset Purchase (LSAP). The Fed buying a set quantity of bonds from private financial institutions
The goal :
to facilitate bank lending and increase money supply
to increase broad money supply even without further bank lending

to lower interest rates for types of risky financial assets
- enlarge the balance sheet of the Fed

misconceptions about QE
- QE gives banks free money
the money is not free because while banks earns interest on the newly created reserves, it also need to pay interest on the newly created deposit

As seen in figure above, pension fund sells gov bond, get cash, buy more risky assets (portfolio rebalancing), support asset prices because of search of yields.

- QE leads to high quantity of M2
customer can use the money to repay loan, and reduce money supply
( customer borrow cheaply, to repay expensive loan)

Monetary Finance
or helicopter money as coined by Milton Friedman
running fiscal deficit, not financed by debt, but by increase in monetary base
such as CB directly credits gov current account, free of interest
- enlarge the balance sheet of CB

Negative Interest Rates
CB charge banks that hold reserve at CB
bank cannot transfer negative rates to deposits, for fear of losing customers
new loans are priced at lower rates
banks net interest income falls
the profit margin between lending and deposit rates is squeezed
banks unwilling to lend -> less bank income -> bank shares fall

the existence of paper currency makes it difficult for CB to take policy rate below zero

Negative Interest Rates policy could be contractionary, as it is a reduction of money supply

Forward Guidance
Management of expectations
let business estimate how long low interest rates may be around
a way of converting low ST interest rates into lower LT interest rates
time inconsistency can be a problem of forward guidance

Financial Crisis
initial phase (credit boom and bust, asset price boom and bust)
->banking crisis->debt deflation
debt deflation: debt become bigger in real terms during deflation

initial phase (credit boom and bust, severe fiscal imbalances)
->currency crisis->financial crisis

wholesale deposits: a deposit at a bank made by institutional investors, such as mutual bank, pension, large business, another bank. It involves large amount of money, and usually short term

** if banks use whole funds as a source of funds, and make long term loan. If wholesale funding dries up, banks could have liquidity problem.

Yield Curve
term spread = 10 yr yield - 2 yr yield  (slope of the yield curve)
stock market is poor indicator of recessions
(the link between stock prices and GDP growth is weak)
yield curve is better indicator of recessions

Breakeven inflation
the rate that make you indifferent between TIPS and nominal bond, if CPI inflation averages to that level over the years
eg. 10 yr breakeven rate = 10 yr nominal treasure yield - 10 yr TIPS yield

if CPI inflation > breakeven inflation, buys TIPS