Unconventional monetary policy of selected central banks

When conventional monetary policy instruments do not suffice to achieve the central bank’s objectives, the central bank can apply unconventional monetary policy measures. The need to adopt such measures can arise in a situation where short-term nominal interest rates are approaching zero amid persisting deflationary pressures and the economy is showing no signs of recovery. The central bank thus has no way of using interest rate policy to further ease the monetary conditions. However, a need for unconventional measures may also arise amid non-zero rates if the interest or credit channel of the monetary policy transmission mechanism is disrupted.

In both the above cases, the central bank is unable to provide the desired stimulus to the real economy using its standard instruments. It is therefore legitimate to pursue unconventional monetary policy. The Bank of Japan (BoJ) did so from 2001 to 2006, and some other central banks, e.g. the Federal Reserve System (Fed), the Bank of England (BoE), the European Central Bank (ECB) and the Swiss National Bank (SNB), have started doing so recently.

Unconventional monetary policy in principle focuses on the costs and availability of external financing for banks, households and non-financial corporations. It therefore involves steering long-term real interest rates. This can be done by (i) affecting interest rate and inflation expectations as important indirect determinants of the long-term real interest rate; (ii) affecting financial asset markets with the aim of directly reducing the long-term nominal interest rate (e.g. by purchasing government bonds) or reducing the risk premium in the yields on certain financial assets. By purchasing government bonds with newly issued money, central banks increase the bank reserves (quantitative effect) and foster lower interest rates (price effect) in order to achieve the desired easing of the financial conditions. With such measures, the central bank simultaneously sends a signal to the economy that it will achieve price growth by issuing money (expectations effect).

The expected and real impacts of central banks’ individual measures are also affected by the decisions on the financing of such operations. The situation where a central bank purchases government bonds and finances the purchase with newly issued money (resulting in growth in the central bank’s balance sheet) is referred to as a quantitative easing.

In the case of a qualitative easing, the asset structure changes in such a way that a portion of the financial assets is sold and the funds raised are used to buy financial assets with different characteristics (usually lower liquidity and higher risk, e.g. private debt instruments). The central bank’s balance sheet does not expand in such transactions. A change in the asset structure amid growth in the central bank’s balance sheet is called a credit easing. The credit easing form is currently the most used, since central banks, in addition to applying the quantitative effect of issuing money, are trying to mitigate the problems with market functioning and monetary policy transmission in specific problem areas.

Table 1 (Box)
Overview of operations of selected central banks primarily influencing the interbank market and smoothness of financing in foreign currencies
(source: central banks)

^a)related to EIB

Table 2 (Box)
Overview of operations of selected central banks primarily influencing long-term interest rates and the exchange rate
(source: central banks)

Table 1 (Box) and Table 2 (Box) outline the range of unconventional monetary policy measures undertaken by selected central banks. Table 1 (Box) summarises refinancing operations, which are focused mainly on easing the funding conditions of financial institutions associated with the limited functioning of the interbank market, and on supporting international financing. Table 2 (Box) describes the use of outright purchases of specific financial assets, i.e. structural changes on the asset side of central bank balance sheets. This table shows that the ECB and the SNB are focusing on purchases of covered bonds, whereas the Fed and the BoE are purchasing government bonds and other private assets. The SNB is the only one of these central banks to have also started intervening in the forex market, with the aim of preventing the Swiss franc from appreciating.