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Central Bank Balance Sheets and
Long Term Forward Rates
Sharon Kozicki
Eric Santor
Lena Suchanek
March 12, 2010
The views expressed in this presentation are those of the authors. No
responsibility for them should be attributed to the Bank of Canada.
1/21
Introduction
• 2007-2009 financial crisis → dramatic policy
response
– Fiscal policy
– Liquidity policy
– Monetary policy
• With severe liquidity problems and policy rates
at the ELB, major central banks (CB) took
unconventional and often unprecedented
measures
• Debate with respect to the effectiveness of CBI
2/21
on interest rates and economic activity
Were Fed purchases of
Treasuries effective?
US 10 Year Treasury Yield
4.5
4
Announcement
of Treasury
Purchases
3.5
3
2.5
2-Sep-09
2-Aug-09
2-Jun-09
2-May-09
2-Apr-09
2-Mar-09
2-Feb-09
2-Jan-09
2
2-Jul-09
US 10 Year Treasury
Yield
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2-Feb-10
2-Mar-10
2-Jan-10
2-Dec-09
2-Nov-09
2-Oct-09
2-Sep-09
2-Aug-09
2-Jul-09
2-Jun-09
2-May-09
2-Apr-09
2-Feb-09
2-Mar-09
2-Jan-09
2-Dec-08
2-Nov-08
2-Oct-08
2-Sep-08
2-Aug-08
2-Jul-08
2-Jun-08
2-May-08
2-Apr-08
2-Feb-08
2-Mar-08
2-Jan-08
Millions of USD
600000
%
Rates have stayed lower since
announcements of Fed purchases of
MBS and agency debt...
Federal Reserve's Purchases of Agency MBS
Conventional Mortgage Rate
1200000
7
1000000
6.5
800000
6
5.5
400000
200000
5
0
4.5
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10-03-01
10-02-01
10-01-01
09-12-01
09-11-01
09-10-01
09-09-01
09-08-01
09-07-01
4.6
09-06-01
4.9
09-05-01
09-04-01
09-03-01
09-02-01
09-01-01
08-12-01
08-11-01
08-10-01
08-09-01
08-08-01
08-07-01
08-06-01
08-05-01
08-04-01
08-03-01
08-02-01
08-01-01
%
UK yields fell with Bank of England
announcement of purchases...
UK 10-year Yields
5.5
5.2
Announcement
of purchases
4.3
4
3.7
3.4
3.1
2.8
5/21
With large-scale asset purchases,
some central bank balance sheets
exploded...
Bank of England's Balance Sheet - Assets
300
250
Billion £
200
150
100
50
0
ST Market Operations
LT Reverse Repos
Acquired Securities
Other
Advances to Government
6/21
At the same time, public debt
levels are rising...
Gross debt as a % GDP
300
250
150
% GDP
200
100
50
Canada
France
Germany
Italy
Japan
United Kingdom
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
1980
0
United States
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Canada
France
Germany
Italy
Japan
United Kingdom
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
1980
80
% GDP
With net public debt rising even
faster...
Net debt as a % GDP
160
140
120
100
60
40
20
0
United States
8/21
Introduction
• Central Bank (CB) initiatives have significant
implications for their balance sheets
– What is the impact of CB balance sheet
expansion on neutral interest rates and longterm interest rates?
• During this crisis, fiscal stimulus plans have led
to large increases in debt
– What is the impact of increased government
indebtedness on neutral interest rates and
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long-term interest rates?
Contribution
• Objective: Examine the impact of the size of CB
balance sheets on long-term interest rates for a
sample of developed countries
• Policy questions:
– What is the neutral rate of interest (important
for planning exit from accommodative policy?
– Will higher interest rates (owing to higher
fiscal debt) derail the recovery?
– Do unconventional policies provide more
flexibility at the ELB, allowing a lower inflation
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target?
Summary
• Objective: Examine the impact of the size of CB
balance sheets on long-term interest rates for a
sample of developed countries
• Model:
– Long-term forward rates
– Encompass the analysis by Laubach (2009)
including fiscal deficits/debt and expand to
also consider CB balance sheet size
• Result: An increase in CB assets is associated
with a decline in long-term forward rates (c.p.) 11/21
Overview
• CB initiatives and balance sheets
• Data & empirical model
• Estimation results: U.S. & panel
• Implications for monetary policy and future
research
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Central Bank Initiatives and
Balance Sheets
• In “normal” times:
– Operational target of central banks in G7: a
short-term interest rate
– Evolution of the balance sheet = endogenous
outcome of meeting this target
• More recently: balance sheets exploded due to
numerous unprecedented initiatives
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Central Bank Initiatives and
Balance Sheets (cont.)
• Liquidity facilities (e.g. TAF)
• Credit facilities (e.g. CPFF)
• Purchase programs (quantitative easing)
• Facilities to deal with insolvency of systemically
important financial institutions (e.g. AIG)
Dramatic implications for CB balance sheets
14/21
15/21
Empirical Framework
• Literature focus: impact of debt/deficit on long
term interest rates
• Model as in Laubach (2009):
Et it  k   0  1Et t  k   2 Et f t  k  3ut  k   t
• Augment regressions by CB variables
Et it  k  0  1Et t k   2 Et f t  k  3ut  k   4cbt   t
16/21
Data for U.S. regressions
• Dependent: 5-year-ahead 10-year forward rate
16
FW514
CY10
14
12
10
8
6
4
2
1980
1985
1990
1995
2000
2005
17/21
Data for U.S. regressions (cont.)
• Dependent: 5-year-ahead 10-year forward rate
• Independent Variables
– Total CB assets and CB claims
14
12
CLAIMS
CBASSETS
10
8
6
4
2
1980
1985
1990
1995
2000
2005
2010
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Data for U.S. regressions (cont.)
• Dependent: 5-year-ahead 10-year forward rate
• Independent Variables
– Total CB assets and CB claims
– 5-year-ahead projected debt, deficit
– Long-horizon inflation expectations
• Frequency: 1980-2007, semi-annually
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Baseline Results: CB Assets
OLS
OLS
IV GMM
Inflation Expectations
1.171***
(0.111)
0.950*** 0.905***
(0.211) (0.196)
Projected Deficit
0.068
(0.047)
0.139**
(0.061)
0.098*
(0.055)
0.717*
(0.417)
0.632**
(0.286)
Projected Growth
Central Bank Assets
R2
DW
Hansen-J
-0.736**
(0.278)
0.904
0.682
-1.200*** -1.167***
(0.431) (0.419)
0.913
0.857
0.993
0.865
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Robustness
• Dependent: current 10-year Treasury yields and
5-year-ahead 5-year forward rates
• Independent: current fiscal variables
• Both CB variables remain statistically significant
and are relatively robust to alternative
specifications
21/21
Data for panel regressions
• Countries: Australia, Canada, Switzerland,
Japan, UK, and US
• Dependent: 10-year government bond yields
• Independent: long-term expected inflation, CB
assets and claims, actual deficit/debt
• Frequency: 1996-2007, quarterly
22/21
Panel regressions
Inflation expectations
Debt
CB Claims
2.356***
1.819***
(0.027)
(0.095)
CB Assets
1.841***
1.712***
(0.104)
(0.096)
0.042***
(0.004)
.005***
(0.005)
0.094***
(0.025)
Deficit
Growth
0.022
(0.034)
0.088**
(0.035)
Claims
-0.336***
(0.027)
-0.120***
(0.020)
CB assets
Instrumented: claims or cbassets
Instruments: inflation, debt (or deficit),
GDP, claims(-1) or cbassets(-1), Inflation(-1)
0.039*
(0.021)
0.011
(0.038)
0.038**
(0.042)
-0.073**
(0.009)
-0.074***
(0.010)
23/21
Caveats
•
Innovations in the balance sheet are simply
proxies for the short-term policy rate
Effect of changes of the CB sheet are overstated
But: forward rates should be immune to
changes in short-term policy rates
•
Negative relationship is driven by trends
Alternative specification using detrended
variables
24/21
Policy implications
• Recent expansion of CB balance sheets →
sizeable effects on long-term forward rates
• But: estimated historical relationship related to
changes in the holdings of treasuries
Many recent initiatives are short-term
Estimated coefficients should be seen as an
upper bound.
25/21
Conclusion
• Examine the impact of the size of CB balance
sheets on long-term interest rates
• Model: Long-term forward rates
• An increase in CB assets is associated with a
decline in long-term forward rates (c.p.)
26/21
Future Research
• Include risk measures (e.g. VIX)
• Case studies (Japan, U.S., U.K.)
27/21