QE/QT effects vary by economic conditions, BoE study finds
A new Bank of England working paper provides evidence that the effects of quantitative easing (QE) and tightening (QT) policies are state contingent. The study uses 60 years of UK data to identify a novel bank funding shock, showing the impact of unconventional monetary policies changes significantly over time.
Unconventional policy, non-recurrent regimes
The research highlights that the impact of QE and QT policies in the UK is dependent on the prevailing economic state, with regimes being non-recurrent.
By analyzing 60 years of UK data on public-sector debt sales to the banking system, the authors identify a novel "bank funding shock.
" This shock reveals that the effects of unconventional monetary policies (UMPs) vary significantly over time, influenced by the policy framework, financial market structure, and real economy conditions.
The study is the first to quantify these state contingencies for each UK QE episode and offers an initial assessment of QT implications.
It also distinguishes between unanticipated and systematic effects, finding that while the unanticipated component is small, the total effect of QE substantially supports output and increases inflation during each episode.
Shifting transmission channels
The paper disentangles the transmission mechanism, observing that the responsiveness of government bond yields to a given amount of QE falls over successive rounds since 2009.
This decline is, however, offset by increased responsiveness of the output gap to gilt yield changes and inflation to the output gap.
The study also finds that aggregate demand in later QE and the most recent QT periods is more responsive to gilt yields.
Furthermore, the inflation/output gap trade-off appears to worsen over QE episodes, reflecting variability in underlying rigidities and increased inflation persistence post-COVID-19.
A call for careful monitoring
This paper delivers crucial insights into the dynamic nature of unconventional monetary policies.
Its findings underscore that policymakers cannot assume consistent effects across different economic states, necessitating continuous vigilance.
For central banks, the research implies a need for highly adaptive policy frameworks and real-time assessment of transmission channels to effectively manage future QE and QT operations.