a game changer for public debt markets? · rome, march, 8, 2018. 2 in theory: portfolio balance, a...

“QE

A game changer for public

debt markets?

Daniel Gros

Rome, Seminar LUISS, SEP

March 8, 2018

Thinking ahead for Europe • Centre for European Policy Studies (CEPS) • www.ceps.eu

Rome, March, 8, 2018

2

In theory:

Portfolio balance, a digression on the US, LSAP versus QE.

In practice:

1. QE euro: A debt management perspective (+ fiscal aspects).

2. Measuring the impact of major ECB decisions

3. Event studies and the random walk hypothesis.

4. Conclusion on fiscal and monetary aspects.

Bernanke: “the problem with QE is

it works in practice, but it doesn’t

work in theory.”


Facts about LSAPS (in US)

• QE1 was preceded by ‘LSAS’ 2007/8

• QE1 did not increase balance sheet (was not supposed to, and was not targeted at Treasury securities).

• QE3 was by far the largest LSAP, but seemingly had smallest effect.

=> All difficult to reconcile with portfolio balance view.

•Centre for European Policy Studies •

www.ceps.eu •3

The Fed’s balance sheet and LSAPs


www.ceps.eu •4

0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

U.S. Treasury Securities Federal Agency Securities Repurchase agreement Foreign currency denominated assets Other assets

QE1 QE2 QE3

14% of GDP

11% of GDP

Portfolio balance effects

• Two conditions:

1. Must have ‘preferred habitat’ investors.

2. Must have asymmetry short- versus long-term securities. (Otherwise some rates go up and others go down, with uncertain effect on demand – a basic point, often overlooked.)

3. (Logical corollary of portfolio balance: higher government debt means higher rates!)


www.ceps.eu •5


www.ceps.eu •6

Portfolio balance effect requires asymmetry

Bond price Price short term paper

Quantity Quantity

Supply after LSAP

Demand curve

Demand curve Supply of deposits

before LSAP

Supply of deposits after LSAP

Supply treasuries before LSAP

Portfolio balance effect requires asymmetry

•Bond

price•Price short

term paper

•Quant

ity•Quant

ity

•

• • • •

•Suppl

y after

LSAP

•Dema

nd

curve

•Dema

nd

curve

•Supply of deposits

before LSAP

•Supply of deposits

after LSAP

•

•Supply

treasuries

before LSAP

•

Portfolio balance effects

• QE should flatten yield curve (central bank buys long bonds and issues short term deposits). But mitigated by:

1. In reality (euro area) NCBs must buy entire curve as they bump against the ‘no blocking minority’ limit on longer terms bonds (in countries with little debt, Germany).

2. ‘Halo’ effect ( et al.): securities with similar maturities are close substitutes.


www.ceps.eu •8

LSAPs and portfolio balance in the US


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Share of Federal Reserve holdings in total US federal debt held by public

Quantitative EasingCentral bank balance sheets andA debt management perspective

Need to distinguish clearly different periods:

• US QE1: financial market instability acute.

• EA: no instability, aim to get inflation up.

Purpose of QE depends on state of financial markets

QE on the balance sheet of the (consolidated) government (% GDP)

Assets

• Few real assets 10

• (Negative equity) 120

----------------------------------

• Government bonds ……………………………20

----------------------------------

Total: 130

Liabilities

• Debt held by the public ..110

• Debt held by the Central Bank …….20

------------------------

• Liabilities of central bank towards commercial banks (excess reserves) ….20

--------------------------

Total: 130

Centre for European Policy Studies •

www.ceps.eu 12

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QE = Monetary policy?

Or rather debt management?

• With own currency can consolidate central bank and treasury.

• QE = exchange of long term bonds against short term central banks deposits.

• => QE lowers average maturity of public debt.

• QE could be undone by more long term issuance by national treasuries; (Greenwood et al. (2016)) ……. also by higher deficits(!)

14

PSPP = Monetary policy?

Or rather national debt management?

• Euro area QE (= PSPP) not considered ‘normal’ monetary policy operation: normal risk sharing rules do not apply to 80 % of purchases.

• All government bonds bought by ‘home’ NCB on own account. (‘ECB buys Italian bonds’)

• Different implementation across countries, maturities differ substantially.

=> Monetary policy no longer ‘single’.

15

Fiscal implications (debt service cost)

• Fiscal gain: lower debt service as long term rates > short term (cost of NCB liabilities zero or negative).

• Fiscal gain low for Germany

• E.g. ten year Bunds at 0.4 %, deposits at minus 0.4 % => total gain 0.8 percentage points on 20 % of GDP: savings = 0.16 % GDP – lower in reality since average maturity < 10 years

• More substantial for periphery: IT: 2 % on BTPs versus 0 cost of Target2 balances on 20 % of GDP => savings = 0.4 % of GDP.

Debt service savings in some cases non-negligible (even with zero impact on Bunds and risk premia)

16

Why should QE reduce risk spreads?

• Since all government bonds purchased by ‘home’ NCB no risk sharing.

• Assume risk premium = PD*LGD

• LGD: goes up since liabilities of the NCBs cannot be restructured.

• PD: goes down: liabilities of NCBs (deposits or Target2 balances) not ‘runnable’!

QE reduces risk of ‘speculative attack’ on national government debt market but increases LGD.

Impact of PSPP on risk premium uncertain

17

In practice:







work in theory.”


Estimating the impact of the PSPP(1) comparative approach

Compare three major moves and how judged today

1. LTRO (Sarko trade), large immediate impact, but crisis resumed after few months = failure?

2. OMT, generally perceived as having large and permanent impact.

3. QE (PSPP)?

For LTRO and OMT evidence is fall in risk premiamonths after announcement and implementation. Apply same metric to PSPP?

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Risk premia (relative to Germany)

Spain Italy Bund yield

LTRO, Sarkozy trade

'What ever it takes'

QE starts : risk premium starts rising

Estimating the impact of the PSPPApplying same metric as to LTRO and OMT

1. Rates fall before and at PSPP announcement = success?

2. Rates rise steeply after implementation starts (like LTRO) = failure?

3. Usual argument: PSPP fully priced in after announcement, rates after implementation not relevant for judgment.

(Same reasoning should apply to OMT, in this case estimated impact would be much smaller.)

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Risk premia (relative to Germany)

Spain Italy

QE announcement QE

implementation

Increase in purchases

Reduction in purchases

Banca d’Italia buys BTP: impact on yield curve?


www.ceps.eu •22

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Italian yield curve: Ten year minus short term (treasury bills)

APP Announcement

APP Introduction

APP Increase APP Decrease

Bundesbank bond buying and the German yield curve


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German yield curve: Ten year minus short term (residual maturity 6 months)

APP Announcement

APP Introduction

APP Increase APP Decrease

The only real ‘Euro’ QE:

• ECB buys supra-nationals (200 billion).

• ECB holds 40 % of all EFSF/ESM bonds, rising towards 50 % (much more than for DE, others).

• Both ECB and ESM are owned by euro area countries. The ECB finances itself with Target balances vis-à-vis the NCBs and thus ultimately with excess reserves.

• Did this asset exchange have any impact on spreads?


www.ceps.eu •24

25

In practice:







work in theory.”


Measuring the impact of QEuro

• Event studies suggest:

• announcements led to lower rates and falls in risk premia of 50-100 bps (e.g. Altavilla et al.).

• But interest rates only intermediate targets: aim is to increase inflation: only modest increases in short term expected inflation and fall in 5/5 year forwards!


www.ceps.eu •26

Announcement effect on inflation?

From Altavilla et al.Euro

Stoxx

(in %)

Inflation swap rates

(in basis points)

1-year 2-year 5-year 10-year 5/5 year

forward

Controlled

event study

1-day

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Standar

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2-da

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change

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www.ceps.eu •27


• Event studies can only measure ‘impact’ on event day. But is it permanent?

• Usual assumption: bond returns are random walk => permanent effect.


www.ceps.eu •28

Illustration of implicit reasoning of event studies


www.ceps.eu •29


• Random walk hypothesis essential to establish permanent effect.

• Can be tested ….. And rejected for many variables, especially spreads and inflation expectations.

• Many bond returns and inflation expectations at all horizons show (very significant) negative autocorrelation

• => announcement effects transitory!


www.ceps.eu •30

Spreads as a random walk?


www.ceps.eu •31

Country Probability (%) Sum of first 5 autocorrelation terms

PT

0.1 -0.05

IT

0 -0.19

IR

2 0.04

GR

0 -0.06

ES 0 -0.19


www.ceps.eu •32

-1

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Autocorrelation function of inflation expectations (by number of years out)

33

Conclusions: Macro


• QE certain way to increase balance sheet of central bank.

• Large movement of assets, but medium term impact on interest rates (and hence asset prices) uncertain.

• No measurable improvement in inflation expectations (some deterioration longer term out).

34

QE: much ado about 2 Trillion (euro)


• QE in euro area: to 80 % parallel national debt management.

• Fiscal impact certain:

1. Maturity of public debt down, but less ‘runnable’.

2. Modest interest savings.

35

Overall conclusion


QE (in euro area) =

Monetary placebo and fiscal Aspirin

=> exit should have no adverse impact on inflation (=> recovery is ‘self-sustaining), but this might be difficult to admit.

a game changer for public debt markets? · rome, march, 8, 2018. 2 in theory: portfolio balance, a...

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