Quantitative Easing and the effects of that on bond market efficiency

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Chapter One: Introduction

The bond markets suffer from anaemic yields, inadequate risk premiums and a lack of liquidity. How to manage a bond portfolio in these circumstances? One can, for example, choose to focus on flexibility and be focused on the management of exposure to interest rates, inflation, and credit and liquidity risk. By becoming able to invest across the bond market without being constrained by a benchmark, the fund manager can react more freely face the changing risk environment and protect against liquidity shocks. The increase in the Fed rate is closer to us and quantitative easing weighing on yields in Europe, the US high yield, products to protect themselves aconceal the purchase gainst inflation, rated structured products and cash are assets relatively attractive today.

Quantitative Easing (QE) became a key element of monetary policy after the financial crisis of 2008, for a number of major Central Banks with interest rates at, or close to, the zero lower bound. QE is defined as purchases of financial assets on large scale in return for Central Bank reserves. Although QE use is widespread, its effectiveness and implementation makes it highly controversial. Moreover, despite the fact that a number of QE programmes are present that can be studied, there are a number of challenges in conducting an empirical analysis of those programmes. The first reason is the absence of a generally accepted theoretical framework for QE assessment for which the theoretical restrictions are either avoided by the empirical studies due to the risk of having their results dismissed as specific models.

Secondly, QE prior to its implementation has been significantly discussed by the participants of the financial market, studies that focus on the announcement effects may lead to misleading results since the QE concept is anticipated to some extent. Thirdly, the reason that QE was implemented as a response to the economic crisis; in this case all the standard endogeneity economic concerns can be applied. Lastly, in this case conventional empirical techniques relying on a rational size cannot be implemented due to the limited number of QE-policy shocks.

The current paper aims to avoid most of the above mentioned problems through empirical approaches focusing on the first UK QE programme’s impact (March 2009 to February 2010). Two empirical approaches are adopted through this paper: First UK government’s macro-finance model is estimated in which a counterfactual estimate can be constructed through the liability curve of the term structure over the QE period and to stimulate the QE impact directly on the yield curve, under some strong assumptions.  The second approach involves a detailed look at the effects of liquidity of the large sample of gilt purchase operations of individual and to assess on to what extent the effects of liquidity go beyond the gilt market. Moreover, the paper also serves to adopt a more qualitative assessment of the QE impacts on monetary aggregates of UK. This assessment will also serve as a useful background to link the obtained results from financial markets to monetary quantities.

Chapter Two: Literature Review

2.1 A brief literature review

In 1961, after the “Operation Twist” work on the large scale asset purchases impact as a monetary policy actually began. In the sense that QE being financed by the base money creation, purchases of Federal Reserves of long term bonds are involved in this operation (short-term Treasury Bills sales finance) as well as the aim of lowering long-term interest rates through change in treasury issuance.  According to Modigliani and Sutch (1966), bond yields had not significantly affected by this operation. However, a recent work by Swanson (2011) shows that this operation impacted market significantly.

Recently, the Bank of Japan implemented the QE programme from 2001 to 2006 through large scale asset purchases that generated new interest in unconventional monetary policy. Ugai (2007) found mixed evidence in a survey study of the Japanese case and concluded that market expectations only received some signalling effects from QE for that the interest rates remain low for a little, however, as far as the impacts of QE operations on the bond yields or risk premia are concerned, the results were mixed.

In 2004 Bernanke et al studied the Japanese experience with QE and found some evidence about the fact that during QE Japanese yields were roughly 50bp lower than expected along with little announcement effects. Expectedly, a dramatic increase in research on this subject matter has been observed after the QE programmes implemented after the financial crisis of 2008. Especially, the significant increase in the growing literature is the result of the Federal Reserve’s QE programme. Some of the names who made important empirical contributions include Doh (2010), D’Amico and King (2010), Gagnon et al (2010), Neely (2010), Hamilton and Wu (2010), Hancock and Passmore (2011), Wright (2011) and (Krishnamurthy and Vissing-Jorgenson (2011).

However, despite of a number of methodological approaches adopted in the US case, the statement that the long-terms bonds are significantly affected by the US programme has reached near agreement; despite the fact that the scale showed estimates that vary considerably. An example is the study conducted by Gagnon et al (2010) who found that UD bond purchases of $300bn that amount to 2% of the GDP approximately resulted in a 90bp drops in 10-year Treasuries in US. However, the study conducted by Krisnamurthy and Vissing-Jorgensen (2010) showed that a reduction of 61 and 115 base points in yields would be made by reduced  public debt outstanding of about 20% of GDP.

As far as the UK’s case is concerned, QE programme has attracted little interest. The empirical estimates recently released by Meier (2009) and then Joyce et al (2010) about the impact of the initial £125bn and then full £200bn on UK gilt yields that is 14% of GDP, show that in the absence of QE the yields would be some 40–100bp higher than in its presence. However, Caglar et al (2011) suggested in his study that the effects may have been overestimated by the event study methodology because of the dominant, impact of the first possibly exaggerated, rather than the announcements of the subsequent six. Thus, the paper aims to make the expectations of the bond price, conditional on the macroeconomic structure in the QE absence, as well as to examine the direct impact of actual purchases made at each auction.

2.2. Quantitative easing and the monetary aggregates

QE can be conveniently described in the UK case through tracing the impacts QE made on narrow and broad monetary aggregates and also helps in furnishing some useful QE associated insights into monetary flows, although this paper does not mainly focus on this.

2.2.1 QE and the Bank of England’s balance sheet

A number of developments made prior to the developments paved the way to full easing although until March 2009 QE stated policy was not implemented. Undoubtedly, the dramatic increase in the sizes of the balance sheet of the Bank of England in September 2009 was the first important step after the Lehman Brothers collapse under the Special Liquidity Scheme. This expansion did not result in an equal expansion of the monetary base as it was financed by the Treasury Bills, although it involved providing liquidity to the banking system of UK that involves acquiring bank assets temporarily in return for liquidity, largely through transactions in reverse repo (Neely, 2010).

In effect the Bank of England holds risky bank assets that are financed by Treasury Bills provided monetary base through repo transactions re-absorbed through financial liabilities issuance. However, it should be noted that some expansion of the monetary base was observed over the period in which banks were allowed to set their targets for reverse balances within a certain range held at the Bank of England, selected to set very high targets for example close to the limit of £1 billion or 2% of the Bank of England’s sterling eligible liabilities asset and earn the low risk free return paid by the Bank of England on reserves. Thus, since unusually large expansion of the monetary base financed the increase in the assets of the Bank of England, over the period a small quantitative easing measure occurred (Neely, 2010).

Important evidence over the same period is the voluntary increase in reserve balances that banks were to safe reserve money but willing low-yielding holders and so when QE was fully implemented the banks were not averse to holding even more revenues. The next step was the implementation of qualitative easing policy in January/February 2009 after an exchange of letters between the Bank of England and the Treasury that happened between January 19 and January 29 (Neely, 2010).

The creation of the Asset Purchase Facility (APF) ion 30th January was a part of it. APF is a separate entity legally run by the bank of England with assurances provided by the Treasury for any possible losses in the form of insurance or indemnity. Initially, it operated through buying of the unsecured corporate commercial paper financed by the Treasury Bills issuing but after further dialogue through exchange of letters between the Treasury and the Bank of England, it was decided to adopt the qualitative easing policy by the monetary policy committee (MPC) between February 17 and March 3, with the aim of £75bn of assets purchases through the APF over the next three months, through an expansion of the monetary base finance (Neely, 2010).

Although the purchase of the corporate debt by the APF continued, most of the purchases made included conventional bonds (gilts) of UK government with a more than 3 years of residual maturity. Both the systems of targets and banks’ reserve holding limits were suspended by the Bank of England for the purpose to facilitate the monetary base expansion and the official interest rate of 0.5% was pledged to be paid on all bank reserve holdings. Thus, at the 7th May the asset purchase target increased from £125 billion in the MPC meeting to £175 billion at the meeting held on 6th August and finally to £200 billion at the fifth meeting held in November the same year.  However, in the MPC meeting held in February, it was decided not to further increase the APF assets stock any further and that resulted in the suspension of QE temporarily since the asset purchase programme was then completed. In October 2011, QE was reintroduced (Neely, 2010).

The UK pension funds and the insurance companies, the Overseas Sector as well as the other UK-based non-bank institutions were the main holders of the gilt prior to the last quarter of the year 2008.  APF quickly after the introduction of QE became the holder of gilt significantly that by the end of 2009, it rose to about 24% of the total stock that is over 13% of the GDP. Despite of this drastic increase in APF holdings, the gilt holdings by other sectors had remarkably little impact, because it was more than the balance in increase in the gilts total stock. Thus, although at a slow rate the gilts holdings by other sectors kept on rising apart from other non-bank institutions in UK such as the household and hedge funds. Another important aspect is the sudden rise gilts holdings by banks since the end of 2008 (Ahmad and Steeley, 2008). This could be observed in the form of increased regulatory pressure on banks for holding more liquid assets. The asset purchasing in the United Kingdom on a large-scale were a conclusion of a set of actions considered to discourse the significances of the crisis of monetary. The measures comprised the delivery of improved fluidity provision; make an action to improve market functioning and quantitative or large-scale treasures acquisitions. On April 2008, Special Liquidity Scheme was introduced and was supported by £185 billion. This scheme permitted banks to exchange mortgage-backed safeties and other assets having less liquidity for reserves. Another facility was come across namely Discount Window Facility (Ahmad and Steeley, 2008).

This competence was introduced to catch the temporary desires of fiscal liquidity organization need support. Moreover, there was the declaration that the bank of England was prepared to bid backup liquidity provision at the rate of consequence and in contradiction of a comprehensive range of security or else solvent monetary organization that were undergoing liquidity difficulties. To talk on market effectiveness, in order to buy first-class viable paper and authentic investment-grade business bonds the bank of England was permitted by an Asset Purchase Facility. Previously when the policy of QE was not presented, these acquisitions were funded by the issuance of reserves bills and the money organization processes of the Debt Management Office.  Similar to the proposal of extra liquidity provision, the information that the central bank was currently in the market for these resources may have better market effectiveness (Kapetanios et al., 2012)

While there are numerous probable networks through which QE may disturb the extensive economy. Most of the examination has highlighted the so-called portfolio balance channel. This operation controls through QE acquisitions commanding up the charges of gold and further possessions that are more identical for gold than cash and this consecutively rouses the petition through subordinate deriving costs and effects of prosperity.

Tobin (1969) pronounced the portfolio balanced models that were further used to regulate the monetary market influence of QE. The estimation of these models is approximately dependable with the event study indication for the United Kingdom (Kapetanios et al., 2012)

The valuation of the possessions of non-standard financial policies on economic variables has mainly depended on event study methods (Ahmad and Steeley, 2008).

In UK, the Bank of England fundamentally increases the upper limit of its QE asset purchase program to £375 billion, out of which most of them is recycled to obtain UK Government safeties. In the area of Euro, the ECB has started a succession of long-lasting refinancing task at the time from 2008 that includes two series of covered bond purchase programs held in 2009 and 2011, an infinite safeties market program in 2010 and flexible absolute monetary business in 2012. By the end of 2012, the central bank of japan cumulatively raises the size of its wide-ranging monetary easing to as much as ¥101 trillion. Currently, the bank of Japan launched the courageous financial easing in the history of modernization with the aim to double the financial vile in two years of duration by violently buying government bonds, real estate speculation trusts as well as exchange-traded reserves. Hence, enhancing the size of their balance sheets this become the principle mean by which Central Banks in these financial prudence have interfered to bring aid to the constant financial recession. By implementing alternative actions of financial easing, Central Bank pursues largely to encourage growth, overthrow unemployment rationally and backing their system of banking by driving more currency into the budget to improve expenditure. On the other hand, certain opponents worry that these methods would provide energy to increment and reassure uncontrolled governmental earnings (Ncube 2014)

The consequences visibly show that the unusual financial measures are actual policy decisions in backup amount stability. Increment in the most important savings would have been lesser or more adverse if the eccentric financial policies had not been commenced by their Central Banks. Most of the outcomes also show that the influence of quantitative easing on financial development is rather imperfect. No substantial effect of QE on GDP development is found for the major financial prudence, excluding UK where growth of GDP would have been as much as 0.7 percentage point’s inferior if the Bank of England had not executed its eccentric financial policies. In spite of the failure of motivating financial activities all together, recreational results recommended that eccentric financial policies somewhat have a constructive effect on industrial manufacturing in the USA, Japan and UK.

Furthermore, investigation found that QE take part in the reduction in joblessness in the Japan and USA, and an increase in inflation potentials in the USA, Euro area and UK. Conversely, indications of the QE’s effects of on households, stock prices, and customer assurance and conversation rates are assorted and thus indecisive. It does appear that financial policy alone is not sufficient, deprived of some organizational improvements and extra policy actions (Ncube 2014)

2.3. QE and the broader monetary aggregates

The focus here is on the bond world. A well-defined process has been established for supporting our investment strategy on understanding and assessment of intrinsic risk factors of a bond portfolio. The main risks are the interest rate (risk of falling or rising interest rates, change in shape of the yield curve and changes in interest rate spreads between different currencies), inflation risks (risk inflation compresses the actual return on nominal bonds), credit risk (the risk that credit spreads may differ due to the reduced creditworthiness of a borrower as a result of a deterioration in the business climate, management decisions, to unfavourable changes in commodity prices, a slowdown in economic growth, a change in policy, a change in the competitive environment, changes in legislation or a change in the general level of borrowing costs), currency risks and liquidity risks (Neely, 2010). Our approach is usually to cover the exchange risk in bond portfolios (what other managers do not necessarily do), but we still have to manage the risk of interest rates, credit risk and liquidity risk. It is currently under the challenge given the historically low level of interest rates, negative returns in the bond market and the structurally weaker market liquidity. The quantitative easing measures adopted by developed markets in particular result in the bond universe generally have duration unmatched for years (with less credit spread protection) (Neely, 2010). In other words, there has long bond portfolios that had not been exposed to the risk of negative performance related to an increase in yields or a widening of credit spreads, and negative real returns from a renewed inflation. Quantitative easing has eliminated the risk and, in my opinion, lowered earnings obtained by investors who assume the risk of interest rates, underlying credit and inflation. In other words, investors are obliged to pay an option premium (lower yields) to be confident that central banks prevent a negative interest rate or credit shock. They do not hesitate to buy bonds from peripheral states in Europe with very low yields because the quantitative easing “ensure” against a sovereign credit event, even if the fundamentals of the region are far from justifying the performance levels / current spread. Thus, the sovereign spreads of countries such as Italy and Spain widened amid fears raised by the course taken by the negotiations between Greece and its creditors. The existence of the option of QE bond purchases is due to the low yield, zero or negative by investors. However, this option premium may be overvalued (Neely, 2010).

Many commentators arguably expected in the early days of QE, including the Bank of England, that rapid growth in the broad monetary aggregates is the main indicator of the success of QE. Overall, during the QE period, the broad money growth was weak. Immediately after the introduction of the QE, M4x growth rate (standard M4 less intermediate other financial corporations, or OFCs) continued to fall to just under 1% at the end of the year 2009 and in 2010 remained below the Bank’s target range that was 6-8% (Neely, 2010).

There may be a number of explanations for the QE, although the low growth rate mentioned above seems odd with its idea of being a factor of boosting bank lending. The first explanation may be that without QE and also taking into account the demand given, there might have been a weaker growth even if not a significant contraction of broad money would happen. Secondly, over the period, UK banking sector issued a significant level of new debt and equity with the aim of recapitalising.  M4x growth tends to be reduced by such issuance for a given level of lending in the banking sector. The non-deposit liabilities capture the measure of the downward pressure caused by the recapitalisation of the UK banks on the money supply (Neely, 2010).

Over the period in which QE is implemented, there was approximately £242bn of the increasing total creation of these liabilities that undermined the impact that monetary boosting might have on the money supply.

If the lending side of the banks balances have been focused, the situation is however similar to M4 deposits. Overall, over the QE period, a fall has been observed in the total M4 lending excluding securitisations and loan transfers by £197.5bn. This fall is reflected in the increase in bank holdings of other banks for example gilts and reserves of Central bank. There have been some recovery in households that is shown by the breakdown in lending by sector over the QE period, that reached about 3% growth at the end of 2009 that continued till 2010 following a contraction in the coming year due to the collapse of the Lehman Brothers. However, no recovery was seen in lending to Private Non-Financial Companies (PNFCs).  The largest contraction was observed in May 2010 with a 4.2% year-on-year contraction with a little signs of improvement afterwards (Neely, 2010).

The overall money growth rate is not consistent with the data on credit conditions from the Bank of England survey. The question as a response of the corporates was that how the availability of credit provided to the corporate sector overall changed by this situation. The published data shows that the expectations can be compared to the actual outturn in the following quarter of the year as the expected balance is moved from one quarter of the year. Before the implementation of QE, the credit availability declined as well as not much improvement was observed until QE was reintroduced. The response of the survey further disaggregated into different factors showed that the actual reason behind the improvement was the changing costs and funds availability due to the increase in the availability of loans in the market. Both of these aspects showed that the loan supply had been affected by the QE (Neely, 2010).

In fact the decision to bypass the banking system altogether and direct issuance of capital expressed the confidence that firms had on the availability of funds. The data on the net capital issuance by PNFCs shows that it consists of primary-market issuance of bonds based in UK and the commercial paper and equity financing by companies domiciled in UK both in the domestic and foreign currencies. Specifically, bonds were the main assets issued by PNFCs over the QE period, and the shares were the second most issued. The commercial paper’s net issuance was negative. Overall, data shows that during the QE period, PNFCs stepped up their net capital issuance; although this might have simply affected the continuing issues in bank financing, the credit conditions seem to have been improved due to the motivation by a desire of the capital market flush to be tapped by the gilt sales proceeds to the QE programme (Neely, 2010).

Quantitative easing is part of a change that the Fed made monetary policy in the United States following the financial crisis of 2008 and 2009. In an effort to help drive economic recovery, the Federal Reserve announced it would buy billions dollars in bonds. As a result, bond prices will rise and bond yields would fall; ultimately, lower interest rates and making it easier for more people qualify for loans (Hancock and Passmore, 2011).

That plan worked. As a result of mass bond purchases made by the Federal Reserve, the bonds became less and less available. Based on the simple laws of supply and demand; with a lower supply of bonds to investors to purchase, they wanted they finally had to pay a higher price and accept lower yields. In turn, interest rates fell throughout the United States (Hancock and Passmore, 2011).

While the Federal Reserve has announced the end of quantitative easing, believe it or not, actually quantitative easing is not ending. I know, the concept seems a little out there, but the truth is really in the details. While the Federal Reserve will not buy bonds, the effects of quantitative easing will continue for some time. That’s because even though the Federal Reserve is not buying more bonds, which are still bondholders that have purchased; and they do not intend to sell them. Because the Federal Reserve still has billions of dollars in bonds bought dollars, these bonds are still out of the market; ultimately reducing the supply, increasing bond prices, reducing yields, and maintain low interest rates in the United States. So while the Fed announced the end of quantitative easing actually QE is far from over (Joyce et al 2010).

Will the Federal Reserve to increase interest rates?

Now that the Federal Reserve has announced that the bond purchase program is over, the debate seems to be in the interest rates. Investors want to answer the question, is the Federal Reserve to raise interest rates soon? There are a couple of reasons for my predictions on interest rates.

Announcement Janet Yellen – The first reason why Joyce et al (2010) does not think that the Federal Reserve will increase interest rates in the short term due to Janet Yellen, she said. During the announcement made about the end of quantitative easing, also said the magic words when it comes to interest rates. Yellen said the Fed will keep interest rates low for a considerable time. While the Federal Reserve is relatively quiet about their movements throughout history, when made an announcement; mostly as advertised comes to fruition.

The recovery is not yet complete – While we see great signs outside the US economy have not yet fully recovered. Because interest rates were reduced in an effort to help the recovery of the US recovery, the Fed would go back if it were to raise interest rates. Therefore, it is very unlikely that something like this would happen (Modigliani and Sutch, 1966).

One of the main economic debates now is the opportunity to QE (quantitative easing) which recently announced the President of the European Central Bank, Mario Draghi. The monthly 60 billion euros that the ECB will be injected into the European economy through the repurchase of bonds (three-quarters from the government and other private issuers) from March this year until September 2016 should impact on inflation and job creation. However this action, which itself takes pages and pages of the brainiest economists, has gone quite unnoticed by the general public despite the significant and permanent effects on the time it will take for Europe in general and Spain in particular.

The quantitative easing (QE) is an unconventional form of monetary policy by a central bank creates money electronically to buy financial assets such as government bonds. This process aims to directly increase private sector spending in the economy and return inflation to the target (Modigliani and Sutch, 1966).

Translated, through the purchase of bonds, usually the government, the amount of money they have holders of these bonds, banks typically increases. As a result, lower bond yields (i.e., they are less attractive for banks) and financial institutions theoretically have more incentive to provide that extra money they have on individuals and the productive sector. To be more likely to get credit flowing in the economy, consumption will increase, increasing the prices of consumer goods and hence inflation.

In a deflationary economy, as Europe now it seems that this should have been done long ago, but as with most things; there are no miracle economics and free action. The problems that arise from the more orthodox monetary tradition relate to the effect on the exchange rate (the expectation is that the euro will depreciate in this context, which in a context like the current drop in commodity prices, especially oil, does not seem very worrisome) and mainly inflation in the European Union upturn (which in some countries would consider as a blessing, this possibility is still something that Germany would never allow) (Meier, 2009).

It seems that for now all fish, bonds at least, is sold. However there are aspects that cannot forget. First we cannot forget that Greece, while under the plan of the European Union, is one of the countries whose bonds are eligible, although Merkel managed to avoid the pooling of bonds and the Hellenic country is relatively small in the European context It is always a risk that is not exempt. On the other hand, as has been proposed by authors such as John Taylor, it is not clear that these measures have had a real effect on the economy, not had in the 70s, and may not have it now (Meier, 2009).

2.4. The serious dangers of quantitative easing

Major European stock markets, such as Germany or the UK, have recently hit highs not seen since 2007. The Asian indices have surged to 19-month highs and the Dow has achieved a new record high. But this bull market is driven primarily by economic reality, but rather by the almost infinite quantitative easing (QE FC) from the Fed that has been replicated by many major countries worldwide. As a result, the world is awash in billions of dollars, yen, pounds, euros and cheap money as there is no profit in other markets; money quite naturally gravitates to the equity markets. But HR can create an army of zombies? Will you go losing effectiveness? Will it create bubbles in the stock markets, housing, credit, bonds, etc.? Nouriel Roubini, the guru of markets and economics professor at New York University, answers to 10 key questions about the costs associated with quantitative easing (Krishnamurthy and Vissing-Jorgensen, 2011).

First, while a purely Austrian response (i.e. austerity) before the outbreak of the credit and asset bubbles may lead to depression, FC policies that excessively postpone the necessary deleveraging in the private and public can create an army of zombies: zombie’s financial institutions, households and firms zombies and eventually government’s zombies. So somewhere between the Austrian and Keynesian ends, it is necessary to gradually remove the FC (Krishnamurthy and Vissing-Jorgensen, 2011).

Second, it repeated FC may be losing effectiveness as transmission channels to the real economy will clog. The channel does not work when bond yields are already low; and the credit channel does not work when banks hoard liquidity and speed collapses. Indeed, who can take credit (companies with higher ratings and better off households) do not want or do not need it, while those who do need -the highly leveraged firms and households in a worse situation-cannot do it the existing credit crunch.

In addition, the channel of the stock market leading to economic recovery after the FC only works in the short term if there is a recovery of growth. And the reduction of real interest rates by an increase in expected inflation when implementing an open FC presents the risk of possibly aggravates inflationary expectations (Neely, 2010).

Thirdly, the transmission channel FC over-the weakening exchange rate of the currency implies a monetary easing is ineffective if several major central banks implemented simultaneously. When that happens, the FC becomes a zero-sum game, for all currencies cannot fall and all the trade balance cannot improve simultaneously. The result, then, is the replacement of currency wars with wars of FC.

Fourth, the FC in advanced economies leads to excessive capital flows to emerging markets; they faced a tough challenge to its policies. Sterilized intervention on the foreign exchange market remains high local interest rates and foreign exchange earnings feed. But unsterilized intervention, or reduce domestic interest rates, it generates excess liquidity can feed domestic inflation and asset bubbles and credit (Neely, 2010).

Simultaneously, renounce intervention and allow the currency to appreciate eroding external competitiveness, and that leads to dangerous deficits in foreign trade. However, it is difficult to implement controls on capital inflows and sometimes, these controls are incomplete. Macroprudential controls on credit growth are useful, but sometimes ineffective to stop asset bubbles when low interest rates continue to hold generous liquidity conditions.

Fifthly, repeated FC can lead to asset bubbles, both in their place of deployment and in those countries for which it is poured. These bubbles can occur in equity markets, housing markets (Hong Kong and Singapore), commodity markets, bond markets (there are those who warn of a bubble that is growing in the United States, Germany, the UK and Japan) and credit markets (where spreads in some emerging markets and corporate bonds of high performance and quality are excessively reducing) (Swanson, 2011).

Although FC may be justified against weak central aspects and economic growth, keeping rates too low for too long may eventually feed into those bubbles. That is what happened in 2000-2006 when the US Federal Reserve. UU. aggressively cut the federal funds rate over 1% during the recession of 2001 and the subsequent weak recovery, and then remained low, fuelling bubbles credit / housing / high risk (Swanson, 2011).

Sixth, the FC can create moral hazard problems by weakening the incentive for governments to implement necessary economic reforms. It may also delay necessary fiscal austerity if large deficits are monetized and, by keeping rates too low; preventing the market imposes discipline (Swanson, 2011).

Seventh, leaving the FC is difficult. If the output is too slow and late, it can generate inflation and asset bubbles / credits. In addition, if the output is given by selling long-term assets acquired during the FC, a sharp rise in interest rates may choke the recovery and generate large financial losses for holders of long-term bonds. And, if the output is running increase the interest rate on excess reserves (to sterilize the effect of a surplus in the monetary base on credit growth), the resulting losses on the balance sheets of central banks could be significant (Nath, 2004).

Eighth, a prolonged period of negative real interest rates implies a redistribution of income and wealth from creditors to debtors and savers and borrowers. Of all the forms of adjustment that can lead to deleveraging (growth, savings, orderly restructuring of debt, or taxes on wealth), the monetization of debt (and possibly higher inflation) is the least democratic and seriously hit the depositors and creditors, including retirees and pension funds (Ahmad and Steeley, 2008).

Ninth, the FC and other unconventional monetary policies can have serious unintended consequences. Eventually it may explode excessive inflation or credit growth may slow down rather than increase, if banks face -at very low net margins on interest-rates decide that the relationship between risk and reward is insufficient (Ahmad and Steeley, 2008).

Finally, there is the risk of losing sight of the locks to conventional monetary policies. Indeed, some countries are setting aside their regimes with inflation targets and moving into uncharted territory, where they could not be anchors price expectations. EE. UU. It has gone from FC1 to FC2, and now, the FC3, which is potentially unlimited and is linked to goal unemployment. Officials are actively discussing the merits of policies with negative rates. And policymakers have adopted a risky credit policy easing off the lower efficiency of the FC (Ahmad and Steeley, 2008).

In summary, conventional policies are becoming less, not more, and clarity about the effects of short-term, unexpected consequences and long-term impacts is scarce. Incidentally, the FC and other unconventional monetary policies have important benefits in the short term. But if these policies are maintained for too long, their side effects can be serious and long-term costs, soaring (Caglar et al 2011).

2.5. Quantitative easing and the Fed Lies

Does the Fed actually reduce its bond purchases during the period of three months from November 2013 to January 2014; apparently not. From November 2013 to January 2014 Belgium, with a GDP of 480 billion dollars, bought $ 141.2 billion of US Treasury bonds. Somehow Belgium arrived with enough money to allocate for a period 3 months 29 percent of their annual purchase of US Treasury bonds. GDP Obviously, Belgium did not have a budget surplus of 141.2 billion Belgium tube a trade surplus for a period of three months equal to 29 percent of GDP Belgium? No, the trade and current accounts in Belgium are in deficit. Does the central bank of Belgium print 141.2 billion dollars in euros in order to make the purchase? No, Belgium is part of the euro system and the central bank cannot increase the money supply. So whence came the 141.2 billion dollars (Steeley, 2015)?

There can be only one source. The money came from the US Federal Reserve, and the purchase was laundered through Belgium in order to hide the fact that bond purchases by the Federal Reserve during November 2013 and January 2014 were 112 billion per month.

In other words, during those three months there was a sharp increase in bond purchases by the Fed in contrast to his announcement of reducing its quantitative easing program (QE). Real bond purchases by the Fed in those three months were 27 billion per month over the original 85 billion monthly purchase and $ 47 billion over the official purchase of the 65 billion dollars a month in that time. (In March 2014, the official QE gradually decreased to 55 billion per month and a planned 45 billion for the month of May). Why the Federal Reserve has to buy bonds above the amounts announced and why the Fed needs to launder and conceal the purchase (Steeley & Matyushkin, 2015)?

conceal the purchase

In short, it is a desperate move by central banks to stimulate a lethargic economy when the usual tools, such as decreases in interest rates in the short term, are no longer effective. In both the euro area and USA interest rates have remained at very low levels since the financial crisis of 2008. However, unlike what happened in the past, low rates have not been sufficient to restore the economy the path of growth (Krishnamurthy and Vissing-Jorgensen, 2011). As it is not possible to continue lowering rates, the ECB and the Fed have embarked on what could be described as an act of desperation, in the dangerous navigation of quantitative easing, which is neither more nor less than to create from nothing, electronically, new money in the central bank’s own account by an appropriate endorsement by computer. These funds are then used to purchase assets such as government bonds, in an attempt to increase the demand for them and forcing downward pressure on interest rates more distant maturities over time, which are normally market forces which must be set, as opposed to short-term rates which marks the central bank itself (Krishnamurthy and Vissing-Jorgensen, 2011).

Of course, once the genius of quantitative easing is out of the bottle, there is no central bank to resist the pressure of political leaders to use these fantastic powers to create money to pursue their political objectives. In the case of USA, the program of quantitative easing by the Fed is essentially used to finance the huge budget deficits of the federal government, so that the money created by the Fed is spent on Treasury bonds already issued. This mechanism is financing a significant fraction of the tremendous budget deficit of the US government, which in turn makes it easier for politicians to postpone hard decisions on spending cuts to reduce the deficit, at least until after the presidential elections (Ugai, 2007).

In the case of Europe, the quantitative easing is subject to, something different but equally destructive political manipulation. Through its Option Long-Term Refinancing (LTRO), the ECB accepts virtually any junk bond that European banks have on their balance sheets (particularly Spanish banks) as collateral for issuing low-interest loans to three years new money to troubled banks, allowing them to actually transmute lead into gold. Incidentally, this process transfers the waste to the ECB balance bulky own bonds.

Although this measure is intended to stimulate the economy by injecting liquidity to banks to enable them to lend money to businesses and households, the result is quite different. In practice, the money received by banks quantitative easing program of the ECB largely used to buy sovereign bonds in the country concerned, they offer higher interest rates several points to the extremely low loading rates on loans the ECB LTRO.  As businesses and families continue without funding from banks with problems, use of the LTRO program is very profitable for the banks themselves, allowing them to obtain good returns given the difference between the two interest rates. Politicians are equally pleased with the massive purchases of sovereign bonds banks make the country itself, which increase the demand for such bonds, driving down interest rates and, ultimately, help finance the budget deficits at a lower cost (Financial Times, 2010).

In world economic history, it has never carried out a similar experiment in quantitative easing at this scale. Nor are there any precedent for such approaches have managed to restore health to any economy, and the on-going efforts of both the Fed and the ECB are also bound to fail. Fatally, as a great deal of money created without basis in the real economy will making its way into that economy, will be feeding a liquidity bubble reflected in higher prices of gold and other commodities, such as oil and basic foodstuffs.  This same bubble will eventually lead to a reversal of the current deflationary environment, with low interest rates, to sharp increases in inflation, which will continue rising interest rates themselves, when finally the central banks are forced to apply anti-inflationary measures (Financial Times, 2010).

When temporary insignificant interest taxes were determined to zero, so in 2009 open market operation for fiscal policy was put forwarded by Federal Reserve. Whereas Fed was effective in letting down interest rates, they were ineffective in receiving the economy quickly get advancement. Sequentially, that controlled the Fed to make an alteration in policies and manage to what has come to be called as quantitative easing (QE). Fed made particularly huge bond acquisitions in late 2008 and remaining over 2009. The purpose behind this was to produce short term interest rates and it knows very well that extra bond purchasing results in reduce interest rates.  Fed enlarges the credit to the bank and backup the financial records interchange for assets and MBS. The quality consumptions are completed by the trading desk at the New York Federal Reserve Bank. About 10% of bank payments were required by Fed this can be held in both in cash in the banks treasuries or at the local Federal Reserve Bank. Economy was encouraged by   quantitative easing in another mode. The federal government sales off large amounts of treasuries to earn for expansionary monetary policy, for instance Fed purchase assets, it upsurge the demand, maintaining assets income low. As assets are the sources for all enduring interest rates, it also retains automobiles, equipment and additional customer obligations rates within their means. This is somehow similar to company bonds, permitting trades and business to develop more economically. Importantly, it possess lasting, low bank loan with fixed interest and it significantly sustenance the housing market. Even prior to the downturn, the Fed balance sheet consist of $700-$800 billion of Capital notes and has a variation in the supply of currency (Amadeo 2015)

2.5.1. QE1 (December 2008 – June 2010)

Fed publicized, it will secure $800 billion in bank obligation, mortgage-backed securities (MBS) and U.S. Treasury notes from associated banks on 25th November 2008. Fed shaped quantitative easing to fight against the economic crisis of 2008 and made effectively pull down the reserves of Fed to zero. Its additional fiscal policy tools were also is very successful. The rate of reduction was almost zero. The interest was even compensated by Fed on banks’ funds. The Fed accepted $175 million in MBS that had been initiated by Fannie Mae, Freddie mac or the Federal Home Loan Bank by 2010 and $1.25 trillion in MBS had been assured by the secured loans. Originally the resolution was to support the banks by taking these subprime MBS off of their balance sheets. In fewer than six months, this hostile acquiring program had more than twice the central bank’s assets. In mid of March and October 2009, the Fed also accepted $300 billion of sustainable treasuries for example 10-year notes.

In June 2010, due to the economy was raising again, the Fed stopped acquisitions. The economy was ongoing to vacillate after two months, so the Fed transformed the program. It brings about $30 billion in a month in order to keep sustainable treasuries to maintain around $2 trillion.

2.5.2. QE2 (November 2010 – June 2011)

Fed declared, it would enhance the quantitative easing on November 3, 2010 by purchasing $600 billion of reserves securities by the termination of the section of 2011. The Fed did shift to buying more enduring bonds relatively that it’s typical instant purchases of bonds. On the other hand it was period when the expression quantitative easing headed noticeably, fed bought $600 billion in assets bonds and this program was specifically proclaimed in august 2010.

2.5.3. Operation Twist (September 2011- December 2012)

Launching of Operation Twist in September 2011 was done by Fed which is somehow comparable to QE2, but two exceptions were present. Firstly, even if temporary assets bills of Fed pass away, if fall for abiding notes. Secondly, the Fed walked up its acquisitions of MBS. These two twists were intended to backing the inactive housing market.

2.5.4. QE3 (September 2012 – October 2014)

The declaration of QE3 was held on September 13, 2012 by Fed. It decided to purchase $40 billion in MBS in addition with a total of $85 billion to bring fluidity a month. Fed had proposed three additional things which it had never done previously. That includes:

  • It proclaimed it would retain the funds rate of Fed at zero till 2015.
  • It thought it would save buying safeties until the jobs emended significantly.
  • Fed proceeded to increase the economy, not elude a reduction (CNBC, Three Things the Fed Did Today its Never Done Before, September 13, 2012)

2.5.5. QE4 (January 2013 – October 2014)

The Fed said it would purchase an overall of $85 billion in enduring assets and MBS in December 2012. The operation twist were ended and in its place temporary bills were progressing up to two conditions were happened moreover joblessness fell inferior to 6.5% or prices rises above 2.5%. Meanwhile QE4 is actually just a postponement of QE3, and some individuals state it as QE3. Further mention it as QE Infinity since it didn’t have a certain end date (Sheehan 2012)

2.6. The advent of quantitative easing in Europe

in Europe

In Europe a full version of quantitative easing will start; begins in March this year. For many of the markets is a relief. They have begun to believe that the expansion of the money, by buying government debt, return the growth of the continent. The hope is that this infusion of new money will stimulate the economy enough to allow the return of lost prosperity of the bygone era. The policymakers of Europe insist that this eventually will deal with ruinous unemployment rates in many parts of Europe, especially among young people, which is dangerously close to 50%. In the case of Spain, this already exceeds that number (Swanson, 2011).


If that were true, it would be the result of adding 1.14 trillion euros, equivalent to 1.27 billion US dollars to the European economy, from March 2015 to September 2016. This would be at a rate of 60 million Euros per month. If it were that simple, every time a nation has a time of low growth and high unemployment, it only would have to expand the money supply to rebalance the economy (Hancock and Passmore, 2011).

The announcement by the European Central Bank (ECB), of the intention to begin the policy of quantitative easing (QE) in Europe, alerted Switzerland to abandon its peg to the Euro. The immediate result was the appreciation of the Swiss franc by 20% against the euro. Despite this increase in value for the franc greatly harm Swiss exports, the Central Bank realized the folly of QE in the long run (Hamilton and Wu, 2010).

The value of the euro relative to the US dollar has also fallen below the trading range over the last 10 years. Now the Euro is at $ 1.12 USD; it is at least 12 years and may further decrease. There are many who fear the 1-1 parity between the euro and the dollar is not far off, as the QE takes over Europe (Hamilton and Wu, 2010).

Hamilton and Wu

Europe has been thriving for 30 years since World War II. The end of the economic transformation of the 1970s saw a strong return to growth across the continent in the decades that followed. Prosperity would be more unequal in all countries. Some countries have begun long periods of slow growth and have reached an impasse (Caglar et al 2011).

Germany go through various economic conditions before deciding, as always, reforms in tax, labour, investment and regulatory matters will best serve the country. Known as the sick man of Europe at the end of the 20th century, Germany returned to the principles and practices of the past, which have served them well. The country’s prospects changed and once again became a model of industrial growth and efficiency. The reward was an increase in exports and tax revenues (Gagnon et al 2010).

Contrary to what central banks do believe everyone, whether a country embarks on a policy of printing a surplus of currency, leading to devaluation, real investment and the money will soon leave the nations; the negative is that it ends up being a net loss for Europe (Gagnon et al 2010).

Gagnon et al 2010

If no structural economic reforms to match QE is unlikely to return to sustainable growth. The continued devaluation would only lead to a growing flight of capital investment. The temporary expansion of the European economy will continue to need an influx of cash to maintain higher prices on assets, stocks and other tangible assets. The stock market has already advanced to the seven years in Europe as a result of the move to QE (Modigliani and Sutch, 1966).

Will there be a rise in exports, since it is cheaper with the decline in the value of the euro? In the short term, this is likely, in the long run, is more doubtful. Much of international investors flee the continent in search of better prospects, competitors exporters adapt to the new price and quality, to maintain its market share (Meier, 2009).


The Japan quantitative easing has tried for years with little result. The United States has made a batch of six years, and yet the US economy is still one of the slowest economic recovery since the end of World War II. The UK also experimented with a dose of it. Europe will realize that only with QE, is not the answer to what the sick economy (Meier, 2009).

The currency war will intensify soon. Denmark lowered their interest rates below cer, to end the Danish crown rapid appreciation in response to the recent statements of the ECB. In North America, Canada has lowered interest rates. Soon it will be a race to the bottom.

One of the promises made by proponents is that the quantitative easing policy fights deflation. This is much truer. If you stay with the policy of QE enough, inflation is more likely to be the problem before too long. Interest rates were reduced in the short term. The reference interest rate of banks for the ECB to keep your money is already below zero. However, the result of QE will be an increase in interest rates in the future in the fight against inflation and low currencies.

Bond yields reached record lows in Europe. The year ended with 10 yields of government bonds last week at 0.54% for France, Germany 0.36% 1.52% Italy and Spain, at 1.37%. Prices are so low that soon will not matter. The Germans, for example, have gone from 1.66 to 0.36% in the last year. As a result, the reference rates of the monetary policy in the United States have dropped from 2.27% to 1.80%; it is not surprising that saving is being cleared in the West (Joyce et al 2010).

Joyce et al 2010

What is it that these lower yields really mean for Europe’s economy? Does anyone believe that if interest rates were a little faeces a torrid be triggered loans for investments and trade expansion? What prevent growth are now rigid labour laws, taxes and onerous regulations that punish the government. All part of the welfare state that is supposed to make Europe a wonderful place for the working classes (Joyce et al 2010).

The direct beneficiary of the easing in Europe will be in the United States in particular. International investors will be attracted to higher yields and better investment opportunities. It is expected that the United States experience better growth rates in 2015, more than most advanced countries in the world (Nath, 2004).

Much of what is the problem in Europe today is the lack of demand, caused by excessive domestic consumption and sovereign debt. Financial institutions, which were in serious trouble during the great recession in the United States and consequently panic in Europe, have been largely stabilized. They are not yet ready to grant new loans and the huge amount of debt in the economy prevent a rebound in consumer demand occurs (Nath, 2004).

Nath, 2004

The current account imbalances

Germany is opposed to further stimulus measures. The thought of his Chancellor, Angela Merkel, which is shared by many Germans, which allows nations as Spain, Italy, Greece and, more recently, France, shed the necessary economic reforms. It also slows down the urgency of them to balance their government budgets. By balancing the primary deficits in the first place, which is current expenditure which does not include interest payments on debt; it is the only way to deal with the broader issue of sovereign debt .The accumulation of all this debt is a heavy burden for the economy of Europe (Hau, Massa and Peress, 2010).

If the West wants to see a return to prosperity will require a time of sacrifice. This means that nations must learn to live within your means. Addiction to consumer debt and level of government necessarily has to end; social programs must be paid for through higher taxes (Hau, Massa and Peress, 2010).

Politicians could not promise government programs that are not effective in cost. In turn, this will stop the need for printing excess currency, which could allow a return to a fixed exchange rate between the major nations of the world. Finally, this could force nations to learn to be more efficient and productive. Once governments around the world are forced to adopt policies that promote greater investment and expanding their businesses, unemployment will decrease. In recent times, it would lead to a new period of growth and prosperity (D’Amico and King, 2010).

The above solution, is it likely to happen? No, as long as the political leaders are still permitiendor central banks print more money and have asset purchase and government debt. The disaster will actually deploy, when investors begin to lose all confidence in national currencies when this time comes, which can report suddenly, there will be a cascade of failures and bankruptcies, which simply overwhelm these financial institutions and safeguards. Markets simply collapse, along with the major currencies of the world, producing untold misery to countless people (D’Amico and King, 2010).

2.7 How does QE works?

QE works in numerous means, but basically it works by levitation of assets values, initial with regime bonds, and then dispersed out by means of extensive economy, this provides an improvement to bank possessions and existing bank loaning and generates a constructive prosperity for asset owners.

While observed extensively as money printing, this is not the situation. Money printing is more related with backing government obligation, relatively than QE, which straight driving money in to the monetary to encourage expenditure.

Bank of England involves the following steps when obeying the law of quantitative easing and gives an outcome with the numerous consistent effects.

Current communal and administration bonds are bought by the Bank of England. These bonds were seized by the private trades such as annuity fund receptacles, insurance companies, private organization and extraordinary lane banks. This can be done by a booster of automated money. These reserves are attributed to the depositor’s financial records that firstly progresses their fluidity (R.A 2015)

The most instant outcome of the asset acquisition is that the values of these prevailing possession increases, though successfully yields revenues and the interest on such incomes bend downwards. This reassures banks and other stakeholders to look to reestablish their collections by capitalizing in other resources with an advanced production for example corporate bonds and dividends (equities). By the occurrence of new venture, the fluidity is re-focused in the direction of the vendor of bond and stake. Moreover, lower incomes push down driving cost for corporate, which can turn as an incentive to deriving and outgoings (R.A 2015)

The intensification in the production of other resources for example stocks and shares that generates the effect of wealth along with the stakeholder who undergoing intensification in their prosperity, motivating expenditure and also hovering confidence and this progressing effect of this possibly blow out to the actual budget.

The expectation is that:

  • The fluidity again twitches the bank loaning criteria, which leads to enlarge the trade and household expenditure.
  • As loaning and payments intensify the confidence increases.
  • The demands of collectives rises which result in the monetary bring out of decline.
  • The price increases and the 2% of the objective is achieved relatively than the reduction inferior to the target that might occur at the time of slump or the phase of less development and reduce opportunities.

In recent times, Klyuev et al (2009) made a discussion on four probable financial substitutes’ activities by central bank throughout a Quantitative Easing government by:

  1. Creating clear pledge to uphold low rates of policy.
  2. Providing extra fluidity to the monetary organizations
  3. Up-setting the enduring interest rates by acquiring government safeties.
  4. Vigorously prevailing transmission to the budget is multifaceted.

The initiative of a large platform of asset acquisitions primarily of UK government bonds or gilts was chiefly proclaimed by the Monetary Policy Committee (MPC) of the Bank of England, on March 5, 2009. The Bank Rate is summarized, specifically the UK policy rate that is up to 0.5% at the same time. Regardless of letting down of policy rates to their actual zero lower bound (ZLB), the MPC manipulated that supplementary measures were essential to attain the 2% CPI inflation objectives in the average period. The purpose of the platform of the asset acquisition funded by the allocation of central bank money was to introduce a large financial motivation into the economy, so as to improve the insignificant outflow and by this means raise national inflation adequately to meet the target of increased prices. In the mid of March 2009 and the end of January 2010 the bank bought a total of £200 billion assets, that signifying about 14% of UK GDP (Kapetanios et al., 2012)

 2.8 The role and structure of corporate bond markets

In the economic system of our financial prudence, the bond market plays a key role. It brings investors and debtors together. They permit investors to invest in comparatively low risk possessions and debtors to attain reserves in moderately liquid markets. Bond markets are significant in defining the price of supplementary assets, interest rate of bank that regularly monitor market-determined interest charges on bonds. The values resolute in the bond markets disturb the domestic decisions to save and the commercial sector’s assets decisions.

In United States, the size of bond market is similar to that of stock market. Out of the total amount of safeties bonds value is roughly about two-third in Europe. But dissemination of the entire debt fluctuates considerably between United States and Europe. In Europe, the bond market is conquered by the bonds of government and the bonds delivered by monetary arbitrators (Biais et al., 2006)

On the other hand in United States, the percentage of bonds delivered by the non-financial business sector is considerable. Moreover, agency bonds and municipal bonds are the main constituents of this market.

In spite of the significant role of the bond markets, there has been far less theoretical consideration dedicated to bond markets than to equity markets. The vast gap is in experimental work and the main cause for this is the availability of data. From the time 1990’s, numerous stock interactions such as the London Stock Exchange, the Paris Bourse and New York Stock Exchange have dispersed high-frequency figures. Many speculative readings have depended on these datasets to brighten the process of the stock markets (Biais et al.,2006 )

Large investment arrivals can be purified by the bond markets. The condition in which bond market of the country was immature the central banks provided only temporary securities to conduct it undeveloped market setup (Mihaljek et al., 2002 and Turner 2002).

Turner (2002), claims that trusting almost completely on temporary securities has likely to motivating a temporary interest rates up and inclines as well to flow the investment partially towards the short-term (L Stewart and Watsonapers 2005)

The efficiency of bond market is much having less consideration than the efficiency of stock market and due to that reason it is eloquent to pay supplementary attention to the bond market changing aspects. Some of the identical factors used to investigate the efficiency of stock market can be used in the analysis of bond market moreover liquidity and transparency are constantly associated to the efficiency of the markets. Though there are also many alterations because of the definite structures of the bond market and for that cause the bond market has to be considered as a distinct object (Backberg 2014).

Limited studies about the efficiency of bond market have been accompanied before but none of these studies have tried to hold the perception of bond market efficiency completely, nor have they been qualitative nature wise and hence, there is a petition for a qualitative study in this field.

Bonds bid numerous compensations over shares and bank finances for delivering businesses and establishment and hence having various constructive results that ascends from operative bond markets. Initially, stock can decline the corporation’s founders that govern decision making, however issuing of bond do not weekend the possessions of recent stockholders. Secondly, bonds are desirable to bank loans as they are offer wealth at lesser interest rates than banks did. Furthermore, when the bonds are gives off straight to the depositors and bank are not acting as a distributor, the driving process becomes extra effective and cheap. Thirdly, the establishments are securing the load of having to exchange with every possible creditor distinctly since a single, even mechanism can be used to meet the adequate money from hundred and even thousands of stockholders (Zipf 1996, 117–118 and Backberg 2014).

2.9. Views of bond markets

The path that leads to lower yields promises thrills. This will perhaps finish with returns of -20 bp in all major markets in Europe, peripheral spreads of 20 to 30 bps from Germany, while yields on US Treasuries and UK Gilts reach new lows.  The bond markets offer little now. Actually, they are not far away, and another performance close to 10 years on the bonds would be enough to place ourselves at these levels. And after that comes come QE. Quantitative easing does work, inflation and growth will they be stronger, or will countries witness an intensification of the “currency war”? This could end badly if the US themselves the objective of lowering the dollar or if quantitative easing is not producing the expected results and any other monetary policy tools are available. A market collapse could then compel policy makers to focus on fiscal policy as the only way to revive growth in real income, investment and job creation (Bernanke, Reinhart and Sack, 2004).

2.9.1. To negative territory

The ECB began to implement its quantitative easing program. The Fed removed the word “patience” in its statement. The entire German yield curve was below that of Japan. George Osborne presented a budget before the elections in the UK and Manchester United regained his game. The theme of divergence in monetary policy remains important for bond investors, but it was shown how difficult it is for the US Federal Reserve and the Bank of England to move away from emergency interest rate when the world is still in the phase of easing monetary policy for fear of further disinflation and growth half-mast. For a short time, from early February to early March, long-term yields in the US and the UK were up, but as soon as the ECB intervened to further lower European yields, the situation suddenly reversed for Treasuries and UK Gilts. When yields on Italian government bonds to 10 years found themselves under those 100bp Treasuries and Gilts, the allocation in response to material assets in such higher yielding context did not waiting. Quantitative easing continues to drive everyone in its wake (Bernanke, Reinhart and Sack, 2004).

2.9.2. The Eurosystem absorbs risk premiums

The short-term momentum is difficult to counter. When UK released quarterly forecasts, it pointed out that during the quantitative easing by the Fed and the Bank of England, the central bank buying up about half of net new issues in Washington and London. However, in the case of the ECB, procurement through quantitative easing should correspond to two times the net emissions. Euros in debt outstanding held by parties other than the ECB will decline, while the situation has not changed in the case of the United States and the United Kingdom. Now that the world of government bonds narrowed as a result of widespread negative returns on debt, the ECB’s measures will strengthen the flattening of the curve and diving yields. Arguably, these developments have fully technical explanation and reflect the relationship between supply and demand. One can also argue that no term risk premium is required on the curve in euros because the ECB will not raise its rates before long. Also, do no sovereign risk premium as quantitative easing guarantees the survival of the euro area and involves the pooling of debt is among the members of the monetary union. More directly, the Italian and German credit risks are now identical (Bernanke, Reinhart and Sack, 2004).

2.9.3. Forgoing Higher Returns

The implementation of the asset purchase program started there about a week. The momentum should be maintained with the only interruptions emissions of government bonds, which will suspend the action of the ECB for one or two days and will offer European banks the opportunity to reposition themselves before the next wave of redemptions. Bullish investors in the European periphery will highlight the considerable budgetary impact of lower interest, which will be favourable from the point of view of fundamentals and growth prospects. Besides the general trend (decline in “core” yields and contraction of peripheral spreads), the impact of quantitative easing on asset allocation and portfolio rebalancing persist. The euro will therefore continue to lose ground. Expect to see more American tourists in Rome, Paris, and Amsterdam and elsewhere this summer the euro approaching parity with the dollar. Other asset classes will therefore also show good performance, including high yield securities (+ 2.78% performance since the beginning of the year for HY securities in euros) and actions. The effect for the Investment Grade credit in Europe is less clear. The performance seems satisfactory, but the investment grade rated securities underperformed government bonds since the early redemption of the ECB (Afonso and Martins, 2010). This is hardly surprising. For starters, the central bank buys large quantities of government bonds. Meanwhile the emissions of corporate bonds also rose sharply. This is European companies seeking to make sustainable borrowing costs that have never been lower and US companies fund themselves cheaply in euros. Spreads are widened and this trend should continue. Emissions companies are unlikely to fill the void left by the massive debt repurchases of the ECB, particularly in terms of duration, but they should help investors. In terms of asset allocation and rebalancing, It has been already mentioned the flow of capital to Gilts and US Treasuries, which are expected to add more from Japan after the end of current year. Therefore, if the Fed and the Bank of England remain evasive about inflation and interest rate forecasts, yields could dip again. In this context, for those of you who are interested in real estate markets, the bubble being formed in Germany has been mentioned several times when we formulated our forecasts. Investors seeking opportunities. Why not a castle on the Rhine? If the rise in asset prices really encourages Europeans to invest and spend, then it will be mission accomplished for the ECB. It remains to be seen (Afonso and Martins, 2010).

2.9.4. CPI shudders

The engine would cause a reversal in global bond markets is clear. It would be marked inflection inflation. However, this has never been unlikely. Oil prices have again plunged last week after the publication of reduced storage capacity in the United States. Few tensions are expected on prices by major sectoral indicators G7 and there is no indication of generalized wage increases. The Fed and the Bank of England will leave us in the dark until there are no signs of a pickup in inflation or, at least, of market inflation expectations. For the curve in euros petrified, signals on the inflation front will be strong enough to cause upward revision of European growth forecasts and inflation of a magnitude that quantitative easing would be abandoned in 2016. In the absence of such a scenario, one can without much effort bet on a further decline in bond yields (of course, it’s one thing to predict the margin of these returns to the down, it is another to buy bonds with negative yields).

The other consequence of monetary easing globally is called currency war. The entire euro zone should welcome the depreciation of the euro against the dollar and many emerging markets are considering different ways to devalue their own currency. The Swiss, Danes and Swedes have already taken the bull by the horns and some British analysts have warned us of the consequences of a rise in the exchange rate of the UK trade weighted. So far, the United States showed composure, but everything suggests that the references to “international conditions” in several FOMC releases are a way of saying that stole the strong dollar could prevent the Fed to achieve the macroeconomic objectives set before any rate hikes. A position of Washington openly hostile to a strong dollar would be a bad sign for the global markets, causing more volatility for interest rate markets, credit and equities. In our experience, if the United States ultimately reacts to the rising dollar, the yen and the Swiss franc will probably remain the best refuges. Considering the unemployment rate and the elections approach, it was doubted that Washington wants to weigh on the dollar for now. Nonetheless, be vigilant, because there is parity with the euro, if the dollar exchange against 150 yen if US economic indicators show a slowdown, the situation could change (Afonso and Martins, 2010).

Chapter Three: Methodology

3.1 QE and the yield curve

As discussed above, defining the actual counterfactual is the fundamental problem in the assessment of the impact of QE on the monetary sector. Here, it is aimed to estimate such a counterfactual for the nominal gilt yield curve to assess whether QE significantly influences the yields. The approach that will be used here includes the estimation of a simple structure model driven by several macroeconomic factors. The model them estimates the predicted yield curve over the QE period to interpret the difference between the predicted and the actual yield curve to estimate the portfolio balance impact of QE as QE is not included as a factor. Obviously, the QE macro impact are reflected in the macro factors that stimulate the yield curve model, therefore through this exercise only the extent to which the yield curve was shifted directly by the large-scale purchases can be identified. This approach is similar to the approach used by Bernanke, Reinhart and Sack (2004) and can be considered as a sophisticated event study because the market model in it is the macro term structure model. Similarly, some ad hoc assumptions have been used to identify the QE impact as a counterfactual approach using the estimated parameters of the model that is an alternative route in estimating the portfolio-balance effect of QE. Both approaches allow the advantage of estimating the long-term impact of QE and not just high-frequency announcement effects.

3.2 A benchmark term structure model

There are two stages for the estimation of the macro-finance term structure model. The first stage was proposed by Svensson (1994) in which the term structure is put into the functional form. The approach applied here is similar to that adopted by Diebold et al (2006) and Afonso and Martins (2010), in which the four latent factors are obtained: level, slope and two curvatures through Kalman filter. In the second step, a SUR regression relates these latent factors to a representative set of macroeconomic variables. Svensson proposed the following functional form:

functional form

A large number of yields of various maturities have been expressed by this factor model approach as a function of a few observed factors. y t )( denotes the yield,  t denotes the maturity and b1 , b 2 , b3 , b 4 , l1 and l2 denote the parameters. The rate of exponential decay is governed by the parameters l1 and l2. The decay will be slower and the fit at the longer maturities will be greater with the smaller value of the lambda.  The decay will be faster and the fit at shorter maturities will be greater with the large value of lambda. The maximum loading of b3 and b 4 is also determined by the lambda. The appropriate factor loadings are corresponded by the parameters b1, b 2, b3 and b 4. The level is constant and can be seen as a long-term factor if termed. All yields will be equally affected by any shift in it. The b 2 factor loading has a functional form starting from 1 decaying monotonically and ending quickly to 0. This is called the slope factor which is considered as a short-term factor. Short-term yields will be greatly affected by a change in b 2 than the longer-term ones, at the same time changing the yield curve slope.

The final two factors b3 and b 4 have loadings that begin at 0 and therefore are not short-term. However, they increase and then decay back to 0 so they cannot also be considered long-term. Such as factor is considered as a medium-term factor and is termed as the curvature. The short and the long end of the yield curve will be affected very little by any change in the b3 and b 4, as on these maturities the yield curve has a very little loading.

Thus, medium-term yields will be increased with any increase in these factors as well as the curvature of the yield curve will also be increased. Thus, the model proposed by Svensson can be interpreted as a dynamic latent factor model in which b1 , b 2 , b3 and b 4 are time-varying parameters that in a given time (t) capture the yield curve’s level ( L ), slope ( S ), first curvature factor (C1 ) and second curvature factor (C2 ).  As Diebold et al (2006) and Afonso and Martins (2010) proposed, it is assumed here that a first-order vector autoregressive process is followed by Lt , t S , C1,t and C2 which allows the model to develop a statespace system. The maximum likelihoods estimates of the parameters are then obtained by the Kalman filter and also the implied estimates of Lt , t S , C1,t and C2,t. A SUR model has been estimated in order to relate these factors to macroeconomic variables as follows:

variables as follows

In the above statement, Y is a 4×1 dependent variables vector, a is the constants vector, a vector of coefficients is r for the lagged dependent variables and a matrix of coefficients of the independent variable is b.

Chapter Four: Result and Analysis

The price of any financial instrument is equal to the present value of cash flows expected to be received in the future. Therefore, to find the price of a bond is necessary to know your cash flow and then discounting it with an interest rate.

In the case of a bond cash flow (cash flow) is given by coupons or interest and the principal. A three-year bond that pays 12 100 annual coupon (6 100 semester) and whose par value is £ 10,000 has the following cash flow: 6 semiannual payments of £ 600 and one for £ 10,000 to be paid within six semesters. For the purposes of calculating the value of a bond must always speak of homogeneous periods of time, which is why it can be said that the principal will be received within six semesters (and not within three years).

After obtaining the cash flow, the second step is to find its present value using the same discount rate. The interest rate or discount rate that an investor expect from a bond is required call (required yield) on the investment performance. The required performance is always related to the return that the investor would have to invest their money in another bond of the same characteristics in terms of credit quality of the issuer, coupon and maturity value. Hence, in practice the required performance is nothing more than the market interest rate for a specified period and level of risk. For this reason, hereinafter the terms required and interest rate market performance will be used interchangeably.

After obtaining the cash flow and the required performance and are able to calculate the price of the bond. The price of a bond is equal to the present value of the cash flow, which is obtained by adding:

  1. a) The present value of the semiannual coupon payments of interest and
  2. b) The present value of principal.


Such that:


P = C + C + … + C + F (1)

(1 + i) 1 (1 + i) 2 (1 + i) n (1 + i) n



P: price of the bond.

C: value of the coupon or interest

n: Number of periods (number of years by number of payments per year.

Example: for a three-year bond with semi-annual payments, n = 3 x 2 = 6 semesters)

i: required (by period, such as six months, in decimal) Performance.

M: nominal or par value or principal.

To calculate the price to pay for a three-year bond issued with a par value of £ 10,000 and coupon 10 100 annual pay in two semiannual instalments of £ 500. The desired yield is 14 100 per year (simple annual rate) and the first coupon will be charged exactly six months.

As mentioned above, the debt market quotes bonds are always made in par value 100. Therefore, the cash flow of this bonus is given for 6 semiannual coupon payments worth 5 (ie, £ 500: 10,000 x 0.05) plus the principal 100 (ie £ 10,000) to be received within six semesters today. The semiannual rate is 7 100 and the first coupon be charged exactly six months. Applying the formula (1), the price to pay for this bond would be 90.46.

P =             5        +       5        +       5        +       5        +        5        +      105    a

(1+0.07)1     (1+0.07)2    (1+0.07)3    (1+0.07)4      (1+0.07)5      (1+0.07)6


P = 4,76 + 4,37 + 4,08 + 3,81 + 3,56 + 69,97 = 90,46

  1. simple annual rate and annual percentage rate (APR O TIR)


In the former case, the 7 100 who have discounted all flows is IRR or effective rate semiannually. To transform the effective rate semi annual effective rate (APR or TIR) use the following formula:


TIR or APR = (1 + i) n – 1 (2)


where “i” is the (monthly, etc) semi-annual effective rate and “n” is the number of periods per year (two in this case).

In this case the APR would be:

APR = (1 + 0.07) 2-1 = 14.49%

The simple annual rate (TAS) just multiply by two. The generic formula is:


TAS = i x n


where “n” it is the number of periods per year.

In our case would TAS: TAS = 0.07 x 2 = 14%.

Relationship between the required performance and the price of a bond

The discount rate is as low as 14-12 per 100 annually: what about the price of the bond? Recalculating the price of the bond with the new interest rate observed rising from 90.46 to 95.08.

This leads to a basic property of the behaviour of bonds: the price of a bond varies always in the opposite direction to changes in the market interest rate. This is because the price of a bond is equal to the present value of cash flows, so that to the extent that amounts (down) the discount rate, the price falls and vice versa.

We can see this clearly in the table presented below: for the bonus indicated in the above example, when the rate is 14 per 100 annually, the bond price is 90.46; when the rate is 12 per 100 price amounts to 95.08 and when the rate falls to 10 100 price rises further to reach a price of 100.

Table 1 Interest rates and bond Price

Interest rate (annual%)                                      Price of bonds / nominal value)


14%                                                                90,46

13%                                                                92,73

12%                                                                95,08

11%                                                                97,50

10%                                                              100,00

9%                                                              102,60

8%                                                              105,20


For a three-year bond, with a coupon par value 100 10 100 annual payable semi-annually.

From the above table are some considerations that should be emphasized emerge:

a) If we graph the values ​​presented in the above table, we get a curve with a convex shape relative to the intersection of the axes (see Figure 1). The convexity of the relative discount rate / price of a bond has a very important role in assessing the profitability of a bond paper.

  1. b) When the value of the coupon (10 100) is equal to the interest rate market (10 per 100), the bond price is equal to par value, ie 100.
  2. c) When the value of the coupon (10 100) is lower than the market rate (eg 14 percent), then the bond price (90.46) is lower than the par value (100). When a bond trades at a value below par value, it is said that trades at a discount.
  3. d) When the value of the coupon (10 100) is higher than the market interest rate (eg 8 percent), then the price of the bond (105.2) is higher than par (100). When a bond trades at a higher value than par value, trading at award says.

Relationship interest rate and bond price

Price Table

4.1. UK – Quantitative easing (QE) from the Bank of England (BoE)

2011 began with UK equities reaching maximum two and a half years. Throughout the first quarter, the markets have been supported by optimistic announcements operations and, in general, corporate profits have been met bullish market expectations. However, there have been many macroeconomic events that have been felt in the confidence of investors. Whether by geopolitical tensions in the Middle East, the resurgence of sovereign debt problems in Europe, or the problem of still existing threat of nuclear contamination in Japan, risk aversion has dominated the headlines. The UK economic data have been mixed. The manufacturing index Markit / CIPS UK has achieved its best record since its introduction in 1982, but inflation has continued to give problems (up to 4.4% in February) and the revised data showed that the UK economy has shrunk 0.5% in the last three months of 2010. Investor confidence has not been favoured by the contradictory statements of policy makers in the UK over the opportunism of a rate increase, and the market is taking consider setting sooner than expected. Despite the increased uncertainty, equity markets have refused to make a substantial settlement. It was not until after the devastating earthquake in Japan that equities have finally experienced a sharp correction that still was short and relatively modest. Having shown remarkable resilience, we closed the quarter with UK equities more or less at the point of departure.

Before 2008, the conduct of monetary policy appeared relatively simple: central banks had the sole objective of low inflation and they reached it by varying their rates. When insufficient demand leads to higher unemployment and deflationary pressures generated, the central bank reduces its interest rates to encourage banks to reduce their lending and more; the easing of financing conditions encourages private agents to borrow and spend, particularly on durable goods, which stimulates the activity, job creation, and reduce deflationary pressures.

Unfortunately, as recalled by the lost decade in Japan or more recently the Great Recession, the presence of the zero lower bound (zero lower bound) greatly limits the ability of monetary authorities to reduce nominal interest rates in the short term deal to a demand shock. In 2008 and 2009, central banks have had to reduce their interest rates closer to zero, but this easing was not enough to stabilize the business and restore full employment; the global financial crisis was so severe that conventional Taylor rule would have recommended negative nominal rates. Also, since the recession coincided with the bursting of asset bubbles, the banking system could not effectively play its role as a financial intermediary, so that market interest rates disconnect policy rates, depriving monetary policy of one of its traditional transmission channels. The savings then risked falling into deflation and it would have fed a vicious circle: the decline in prices in a context of zero nominal interest rates strongly pushes real interest rates to rise, which worsens back deflationary pressures and recession.

CHART 1 Active Fed (billions of dollars)


Source: FRED (2014)

Constrained by the zero lower bound, central banks had to then adopt measures “unconventional” to further stimulate activity. One of them is the practice of forward guidance consisting of the central bank to play, via its communications on agents’ expectations. Central banks have also conducted large-scale asset purchases (large scale asset purchases Single), what is more commonly called “quantitative easing” (quantitative easing). These purchases may as well be on private assets than government bonds. For example, in November 2008, the Fed announced purchases of securities-backed mortgages for an amount totalling $ 600 billion. In March 2009, it extended its purchases of securities in longer-term Treasuries. Total purchases amounted to 1750 billion dollar, representing a double amount of assets the Fed before 2008. On 3 November 2010, the Fed launched a second quantitative easing under which it would make the acquisition of long-term Treasury securities for an amount totalling $ 600 billion. The Federal Reserve announced a third quantitative easing September 13, 2012 that would lead to purchase each month the equivalent of $ 40 billion in securities backed by mortgages on. On 12 December 2012, this amount is increased to $ 85 billion per month. With the on-going recovery in activity, the central bank announced a slowdown in 2013 (tapering) in asset purchases. Over the years, these various purchases have helped to significantly increase the size of the Fed balance sheet ( cf . Chart 1). The Bank of England has also conducted quantitative easing programs from September 2009 and they have also led to sharply boost its balance sheet ( cf . Chart 2).

CHART 2 Assets of the Bank of England (billions of pounds)

billions of pounds

Source: Fred (2014)

The main objective of these asset purchases is to more fully reduce the long-term interest rates to facilitate borrowing by households and businesses to stimulate aggregate real economic activity and demand. The asset purchases are likely to influence long-term interest rates through multiple transmission channels. The theoretical literature places particular emphasis on the “portfolio rebalancing channel” (portfolio balance channel).This assumes that there is no perfect substitutability between securities in the portfolios of financial investors, so that variations in the supply of an asset affect its performance and that of similar assets, which brings private investors to change the composition of their portfolios. For example, purchases of long-term Treasury securities which carry the central bank reduce yields of these securities and pushing investors to hold other assets, which also reduces the efficiency of these and increases their prices. Lower yields and rising asset prices soften financing conditions, while the owners of assets can realize capital gains. If households consume more, or if the companies invest more, while total demand is increasing and activity is stimulated. The literature also suggested the existence of a “signalling channel” (signalling channel): asset purchases indicate to market participants that the central bank wants to keep interest rates low for an extended period (Bauer and Rudebusch, 2011). Since making such purchases central bank is exposed to potential losses, they signal its commitment not to raise rates soon. Anticipating low levels of short-term interest in the future, market participants reduce long-term interest rate they demand, which stimulates new investment.

Empirical studies suggest that the asset purchases have actually led to lower long-term interest rates, including reducing term premiums Gagnon et al , 2011; D’Amico et al , 2012; Hamilton and Wu, 2012; Baumeister and Benati, 2013) . They also suggested that these unconventional measures had led to acceleration in growth and inflation (Baumeister and Benati, 2013). Here, Martin Weale and Tomasz Wieladek (2014) analyzed the impact of purchases of government bonds by the Fed and the Bank of England on real GDP and the price index of the US consumption and the United Kingdom. Since it concerns the period between 2009 and 2013, their study has the advantage of taking more perspective than previous to assess the impact of non-standard measures adopted by the two central banks during the Great Recession. According to their estimates, asset purchases have a statistically significant effect on real GDP, since purchases of 1% of GDP leads, firstly, to a real GDP growth of 0.36% in the United States and 0.18% in the UK and on the other hand, to a rise in the consumer price index of 0.38% in the US and 0.3% in the UK.

Weale and Wielade continue their analysis by identifying the transmission channels used by the unconventional policy of the Fed and the Bank of England. In the US, asset purchases reduce yields on long-term bonds and the real exchange rate, which suggests that the portfolio rebalancing channel plays an essential role in the transmission of this unconventional monetary policy the US economy. In the UK, these are the future interest rate indicators and uncertainty in the financial markets that are most affected by the asset purchases, which suggests that they mainly affect the British economy through the alert channel.

These results suggest that asset purchases may be effective to stabilize production and prices. They have indeed supported the recovery in economic activity in the United States and the United Kingdom. The ECB has so far refused to adopt a quantitative easing program, despite economic growth more sustainable deteriorated in the Eurozone than in the US and across the Channel. The extreme weakness of Eurozone inflation, making it more likely the tipping into a deflationary trap, recently urged the ECB not to rule out asset purchases as an option to bring inflation to its target. However the central bank said it was prepared to adopt such measures if the inflation figures deteriorated further. According to Eurostat estimates published yesterday, the annual inflation rate in the euro area would have reached 0.7% in April, after reaching 0.5% in March. This slight acceleration could prompt the ECB to opt for the status quo . However, not only the rate of inflation remains far from its target, which could lead to a destabilization of inflation expectations and affect the credibility of the central bank, but several member countries have already switched to gold and deflation and, regarding the rest of the euro area, even a very low inflation (low flation) is likely to generate dynamic debt deflation.

4.2. Discussion

4.2.1. The new program of quantitative easing from the ECB would have no effect on the real economy

The ECB announced at the meeting of the Governing Council of January 22, 2015 expanding its asset purchase program by the private sector, to now include government bonds, in particular, debt issued by central governments of the euro area agencies and European institutions.

This expanded program also includes the purchase program of asset securitization bonds (ABSPP) and the purchase program covered bonds (CBPP3) started in the last months of 2014. Monthly purchases represent a total of 60,000 million euros. These purchases are expected to continue at least until September 2016 and, in any case, until a sustained adjustment path of inflation that is consistent with its objective of maintaining inflation rates at levels below consolidates, though close to, 2% over the medium term (Mann & Klachkin, 2015).

The goal of the expanded program of purchases of private and public assets is to provide monetary stimulus to the economy of the euro area in a context in which official interest rates of the ECB are close to 0%. In addition to the expanded program it is to substantially ease monetary and financial conditions, lowering the access of non-financial companies and households to bank credit and, ultimately, promote productive investment and household consumption (Hamilton and Wu, 2010).

But this new program of quantitative easing from the ECB will have effects on economic growth?

Some conditions imposed in the enlarged ECB purchases program generated serious doubts as to its effectiveness to drive growth in the euro area (Svensson, 1994):

The new program of quantitative easing is very limited in amount

The graph (click on it to view larger) can be seen as the goal is to inject an additional 1.14 billion euros until September 2016, leading the current balance of the ECB (2.158 billion euros, January 16, 2015) to 3.3 billion, slightly above the amount it held in March 2012 (3,023 billion euros). In short, this is a program of quantitative easing or purchases of large-scale debt (QE) bit ambitious, since it exceeds the levels ECB balance sheet 2012 slightly, which were declining in 2013 and 2014 Because of the repayment by banks of loans provided by financing operations in the longer term (VLTRO).


First, with respect to the distribution of potential losses of the program, the Governing Council decided that only 20% of asset purchases will be covered in solidarity. The other 80% will be covered by the national central banks. The lack of cohesion between the countries is manifested as part of mutualise risks are not (Mann & Klachkin, 2015).

Secondly, the expanded program focuses on the sovereign debt of countries in the euro zone and agencies established in the euro area or international or supranational institutions (which include the European Stability Mechanism, ESM). This would exclude corporate debt, unlike the QE programs US Federal Reserve

Thirdly, purchases of assets are distributed among the countries of the euro area based on each country’s participation in the ECB’s capital. The lack of solidarity among countries absent (Lai, 2015).

Finally, the ECB asset purchases are self-limiting unlike the QE programs US Federal Reserve On the one hand; they may not exceed 33% of the outstanding debt of the issuer and, on the other hand, may not exceed 25% of the total amount of an issue.

  1. The new program of quantitative easing can provide liquidity to banks but does not mean to boost lending to non-financial corporations and households

On the one hand, the ECB argues that this program may have effects on the real economy as banks of the euro area can take the portfolio of public debt from their balance sheets and use the liquidity obtained to provide credit to non-financial corporations and households. But it could also be used liquidity to repay the debt of the banks themselves or to reuse the ease ECB deposit, even negative nominal interest rates. If banks do not just transforming the new liquidity provided by the expanded program of asset purchases is because the pressure to raise the bank solvency is maintained with the Basel III rules and stricter rules adopted by the G-20 for large banks of the euro area (credit supply problem) (Lai, 2015).

The new program of quantitative easing can provide liquidity to banks but runs into over-indebtedness of non-financial corporations and households 

The debt of non-financial corporations and households in the euro area is still excessive. The problem is that nobody wants to borrow even if nominal interest rates low. What they want non-financial companies and households is to continue deleveraging, i.e., return the accumulated debt in the economic boom (credit demand problem).

In this regard, credit demand will not recover while aggregate demand, mainly household consumption and private investment will not recover. The ECB acknowledges that without a fiscal expansion focused on increasing public investment – which is a relaxation of fiscal adjustments imposed in recent years without structural reforms in the economies of the euro area, its expanded asset purchase program could fail in order to revive the economy of the euro area (D’Amico and King, 2010).

The two transactions were VLTRO provided massive injections of liquidity to banks at fixed interest. The first operation was allotted on December 21, 2011 and the second on February 30, 2012, with an amount of 591 531 and 489 191 billion euros, respectively. The use of these operations with a maturity of three years was the instrument that had the most impact on the expansion of liquidity, causing an easing of tensions in the banking sector. However, this measure did not push financial institutions to increase lending to the private sector (Joyce et al 2011). This liquidity was primarily intended purchases of sovereign debt, thereby causing a relief of the risk premium. But another part was used to deposit in accounts that banks have in the ECB (deposit facilities), so that the money came partly at the hands of the ECB. In short, these massive injections of liquidity accounted for easing tensions in the credit sector, but did not resolve the major problems of solvency suffered by credit institutions or imbalances that caused instability in the Eurozone, and liquidity drought suffered by the private sector (Joyce et al 2011).

One reason for the devaluation is that, when economic growth is weak, as it has been all over the world for five years, governments experiencing strong pressure to increase exports and reduce imports for the purpose of restoring growth. Often, that means lowering the value of the currency; so that the products are sent abroad less expensive in relative terms and is more expensive than those entering the country (D’Amico and King, 2010).

The European Central Bank, for example, you depress the euro to ward off deflation. The previous strong euro lowered import prices and forced local producers to compete with imports at lower prices. The result was that inflation in consumer prices was down and approaching zero. In October was just 0.4% from the same month last year (Wright, 2011).

The economy of the euro area remains stagnant and the possibility of a third recession since 2007. Unemployment is high. Unemployment among young people is over 25% in many countries and over 50% in Spain and Greece. Meanwhile, consumer sentiment, which never recovered from the last recession, decline again (D’Amico and King, 2010).

In early June, the ECB reacted by lowering its benchmark interest rate from 0.25% to 0.15%. While these measures were more symbolic than anything else, the euro declined. In September, the ECB began to make available to banks up to 1 trillion euros in cheap loans to four years provided that facilitate credit to the private sector (D’Amico and King, 2010).

4.2.2. European QE

However, the measures did not produce a substantial drop in the euro, so the president of the ECB , Mario Draghi, announced in September a further reduction in the interest rate of 24 hours, to 0.05%, and increased to 0.2% of the fee to be paid by banks on deposits at the central bank (Hancock and Passmore, 2011). In October, the ECB bought a wide range of securities, including bonds secured by auto loans, mortgages and credit card debt, in order to encourage lenders to offer more credit to companies. Also these measures have proved more symbolic than anything else, but the euro has weakened somewhat (Anderson and Sleath, 1999).

While it is likely that the ECB will end up implementing any kind of direct quantitative easing, it should be noted that the QE is less effective in the euro area. The funding focuses on banks, which represent 70% of business financing, and not in the bond markets, and the United States, where the QE way into the economy quickly (Hancock and Passmore, 2011). Moreover, the weak banks of the euro area are affected as a result of poorly performing loans, anaemic profits and the need to raise capital to meet the new demands of regulators. In addition, countries in the euro area are 18 and, therefore, the ECB has to consider 18 different bond markets (Afonso and Martins, 2010).

Anderson and Sleath (1999) believe that purchases of long-term securities tend to depress yields and make them less attractive in the eyes of foreign buyers, which once again materialize the goal of the ECB to weaken the euro. A weaker euro would alienate even more to foreigners, which would lead to further declines. Low interest rates could also encourage long-term decision-credit and economic activity in the euro area, which Draghi drives (Hancock and Passmore, 2011).

4.2.3. Feudal hindrances

As Japan has the lowest birth rate among the G-7 and lacks legal immigration (characterized by attracting people of working age), the country’s population declines. The result is that a shrinking labour force should provide resources for a growing number of retirees. It does not help that the Japanese have the highest life expectancy among developed countries (Hau, Massa and Peress, 2010).

According to Wright (2011) Japan could address their problems with structural reforms, which are the third tool Abe. These reforms, however, are difficult to implement in a country that, until the end of the century XIX, was immersed in feudalism.

In feudal societies, women do not work outside the home and the man must be loyal for life to his feudal lord. Today, as usual in Japan it is that women and men do not work aspire to lifetime employment. Since discourage layoffs by companies, they have no room for new hires. Moreover, mergers of companies, increasing efficiency, are rare in Japan, another obstacle of feudalism (Wright, 2011).

However, the government of Abe discusses some less drastic structural reforms that could improve the growth potential of Japan. A reduction in the highest category of corporate tax, more than 35% to less than 30%, more in line with the average of 29% in developed countries, is a possibility.

The creation of special economic zones that would give companies the freedom to cut red tape that limits everything from hiring and firing up management and land ownership is also evaluated (Anderson and Sleath, 1999).

If anything, Abe has trouble using its second and third tools, fiscal stimulus and structural reforms. You will have to rely primarily on the first, the monetary stimulus, which will have a negative effective on the yen. In fact, the Bank of Japan said on October 31 that will accelerate over a third buying government bonds, while fund buying triple traded investment trusts and real estate (Wright, 2011).

Finally, there is also the risk of liquidity. For fund managers and all investors, this currently constitutes a real cause for concern. It is clear to all participants in the bond market that the liquidity of the market is facing a structural problem. Several institutions, including the IMF, recently expressed on this and there are fears of market disruptions exacerbated by the drying up of liquidity in case of negative reaction to a rise in US interest rates. For the managers of mutual funds, this can lead to a sharp increase in redemption requests by clients wishing to ensure that their bond positions will suffer losses because of rising interest rates. Strong constraints on regulation and equity imposes on the capacity of market liquidity providers (banks), compared to the period before the crisis and this could worsen if renewed risk aversion a market on. This does not mean that investors will not be able to exit bond positions or that there will be no buyers, but prices will be much lower than they would normally. They could become more volatile and the “credit” environment could deteriorate beyond what the fundamentals would justify. Even in 2008 and 2009, the obligations were trading at distressed prices due to sales emergency and lack of liquidity were safe and generated a very good performance for those who had the presence of mind to buy at that time. It is difficult to anticipate a liquidity event, but we can say without really safe to say that a rise in volatility will be linked to a liquidity crisis and that these two phenomena could be triggered by the start of a new cycle Fed interest rates (Joyce et al 2011). Unconstrained of bond management approach (or even other fund types) offers the ability to hold more cash than usual when liquidity risk is likely to increase. After all, the opportunity cost associated with owning liquidity is low in a world where traditional safe haven assets show a negative return. By providing liquidity during times of increased market volatility, fund managers have the opportunity to invest in better prices. An even better solution is to replace some highly rated bonds normally liquid by more structured assets such as ABS or CLO, provided they have a very low duration, but often spreads higher than those of investment grade rated securities. The combination of liquidity and quality of structured products currently a good defensive heart for an unconstrained bond portfolio (Joyce et al 2011).

Chapter Five: Conclusion

In conclusion, quantitative easing can be considered as an important monetary tool taking into account its significance in many countries over recent years. However, it is a fact that its effectiveness still remains a question as it is not clear. Several approaches have been adopted through this study to assess the financial market impact of QE and it is found in all cases that it has a significant important effect on the bond market economically. Quantitative easing has traced all assets, but this effect will eventually fade. Some consider a return of 0.17% for Bunds to 10 years is ridiculous and unlikely to attract investors. Yet it is difficult to predict when the turnaround will occur. The risk through a particularly difficult economic and financial period, growth is sluggish, inflation is low, and the dynamism of the labour markets is not enough to trigger an increase in real wages. Politicians are incapable of bridging the productivity gap, the financial system is and will remain in the rut as banks and insurers will face reduced margins and that regulators continue to penalize risk-taking. Meanwhile, geopolitical factors of concern. In the land of deflation, bonds 1 basis point is queens. If the US market for high yield bonds still offer me 6% and its European equivalent, at least 4%, and that  Countries are still able to enjoy perpetual optimism in equity markets, it is there we need to invest. Investors may also turn their eyes to leveraged loans and CLO, where floating rates and widening spreads are an attractive option at a time when the liquid segments of the bond market are very expensive, especially Europe. Nevertheless, a successful investment strategy over the next 5 to 10 years not be to obtain a final extra of financial assets already overvalued performance, but rather to acquire adequate coverage in anticipation of unfavourable conditions. This would not be necessary if policymakers took the necessary measures to boost productivity, improve real disposable incomes and encourage long-term investment (after all, it is possible to finance more cheaply), but , as demonstrated by the UK this week, political courage and the ability to project over the long term are lacking. The political orientation could eventually change, but it is likely that quantitative easing is seen as a failure that entails a very negative market reaction. It seems that the evidence provided here will be contributing to the growing consensus about the significance of QE in terms of influencing long-term bond yields through a portfolio-balance effect, along with the growing evidence for the US. However, the QE impacts on other assets and on the economy in broader terms remain controversial as confirmed by the qualitative description of the QE impact on monetary aggregates. Certainly, this question seems to be remained unsolved for some time due to the fact that QE was implemented during a credit crunch, a period with monetary policy having uncertain effects. A general-to-specific approach have been performed here to achieve the final equations determined here.


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