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I have been reading recently on the quantitative easing programmes by the ECB and the BOJ, see http://www.cnbc.com/2016/04/07/what-the-bank-of-japan-boj-will-do-now-that-negative-rates-have-disappointed.html, and, http://www.bloomberg.com/news/articles/2016-04-21/ecb-to-start-buying-corporate-bonds-in-june-as-part-of-stimulus.

The ECB will be expanding its current programme to include corporate bonds and it is being suggested that the BOJ may give up on negative interest rates and possibly could buy japanese equities instead. It seems that these central banks are just working their way up the risk asset spectrum. My question is where do these asset buying programmes stop (penny stocks/distressed debt?)? Also what happens to these assets, surely if they sit on the central banks books it could go bankrupt like a commercial bank? Moreover, what could cause these asset buying programmes to be abandoned/fail?

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  • $\begingroup$ Well my best guess is: it stops where they say it stops... But then comes the question of credibility ! $\endgroup$ – Alexis L. Apr 23 '16 at 23:02
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1) In principle, there is nothing material to stop the central banks. Apparently, during the great recession in the 1930's in the US, the fed bought even stranger stuff. They could go domestic bonds, equities, houses, etc, and then they could go to foreign assets.

2) No, they cannot literally go bankrupt because they can always print money. Some banks have in fact begun to consider printing money as a way to forcefully lower the value of their currencies.

3) My guess is that the issue is really the opposite one. Banks are doing too well: they buy assets, and those assets do well, then the bank is actually backing up each unit of currency with more value than before. It's hard to create inflation like that.

4) The practical limits are twofold: it might be politically unsustainable. A) Sooner or later the public thinks this is useless and they elect a new central banker or ask the president to appoint a new one. B) It might create all kinds of strange incentives. For example, you might want to bribe the central bank reserve's managers to buy your company's assets.

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There are other limits that "Fix.B." didn't bring up.

Central banks may do more harm than good, says head of India’s central bank - MarketWatch

MarketWatch: For the European Central Bank, the Bank of Japan and the Fed, the best thing for now would be to stop moving in the easing direction?

Rajan: My sense is industrial countries’ central banks should probably consider whether they are doing more harm than good by easing further. I don’t think the benefits beyond a certain point have been that clear, and certainly the costs of staying in this ultra-accommodative phase for much longer will build up – the known costs – and then there are less-known costs. How much are we, with these policies, preventing adjustments that should take place. I know this has got a bad name, it is the “liquidationist” or “Austrian” view, but it is a very real question of whether we’ve allowed the adjustments to take place enough or whether we’re keeping too many inefficient firms alive.

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MarketWatch: You’ve said you’re concerned with the wealth effect of quantitiative easing – that asset prices have gone up and investors are worried they are going to come back to earth.

Rajan: This is the problem of the bridges. If you build a bridge it has to reach to the other side. So I think a bridge that relies on wealth effects, you better hope that you got enough growth to justify the asset price increase which created the wealth effect in the first place. So there is some sort of virtuous cycle that gets kicked off which becomes self-fulfilling over time. The alternative is you kick off the wealth effect now, but over time people realize the wealth ain’t coming and then you have an asset price adjustment. I think the jury is still out on which one we’re going to go through.

Why can't central banks increase the scale of quantitative easing? : AskEconomics

/u/say_wot_again has expressed concern over the level of ownerships the BoJ has taken in terms of Japanese assets, so I suppose there are considerations wrt the affect that holding substantial percentages in an economy's stock financial market may have.

Serious question. What are the drawbacks of UQE (Unlimited quantitative easing)? Where/does it ever end? : AskEconomics

Quantitative easing strategies can also artificially prop up inefficient "zombie" corporations by artificially raising the demand of their corporate bonds - which usually results in lower yields. Of course, this really depends on which corporations the Central Banks purchase bonds and other securities from, how the government chooses to spend money, and the liquidity situation of banking institutions.

But this moral hazard is probably necessary. WSB wrongly believes that the Fed has removed any incentive for companies to act responsibly in the future. : badeconomics

As someone who has studied financial crashes extensively, the simple rebuttal to the WSB post is that concerns about moral hazard are insignificant compared to concerns about the continued existence of the financial system. Existential threats trump all, and when the money market seized up a month ago, we had an existential threat.

More pragmatically, let's assume that (hypothetically) 25% of all companies are poorly run and a bailout would reward that bad behavior. That leaves 75% which are illiquid, not insolvent. When the market tanks, it tends to do so very rapidly, which means that policy-makers don't have the time to do a granular examination to decide which companies are good and which ones are bad. Furthermore, the banks which back the companies typically pull out of as much lending as they can, for the same reason. The 75% healthy companies are now imperiled just like all the others.

In these situations, policy-makers have to decide if they want to have some waste and some moral hazard created as a result of a bailout, or if they want to run the risk of things getting way worse as they do their inspections. Sometimes they try to be granular or make an example of poorly-run companies and it works (LTCM), but sometimes that example-setting scares everyone else completely to death and creates an imminent death spiral (Lehman). Powell is choosing not to take the risk.

Once the economic dust settles and things are stable again, our politicians and central bankers will once again resume solemnly intoning against the dangers of moral hazard and the virtues of capitalistic competition. But in the next severe crash, I guarantee you that those concerns will fly out the window and we will do bailouts again.

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