1980s UK overfunding policy informs quantitative tightening
A new Bank of England working paper provides the first in-depth empirical assessment of Britain's 1980s 'overfunding' policy. The study reveals that this historical monetary tool, involving excess government bond issuance, offers valuable insights for current quantitative tightening strategies.
Overfunding's dual impact on asset prices
Overfunding, a policy of government bond issuance exceeding fiscal financing needs, was actively used in the early 1980s to curb money growth.
The empirical assessment shows that overfunding shocks had countervailing effects on asset prices.
Excess gilt issuance led to higher long-term yields through a portfolio balance channel, while simultaneously reducing short-term rates, potentially via signalling effects.
These offsetting forces resulted in limited overall effects on inflation and monetary aggregates.
The paper highlights that overfunding operated through the same transmission channels—portfolio balance and signalling—that are central to modern balance sheet policies, including a clear duration risk mechanism.
This historical episode demonstrates how different channels of balance sheet policy can interact to produce complex aggregate outcomes, offering a nuanced perspective for today's policymakers.
Unlocking historical policy with novel data
The paper employs a novel external instrument derived from the segmented UK money market of the 1980s to identify overfunding shocks.
Overfunding operations drained money market liquidity, prompting the Bank to intervene in specific segments, creating a wedge between bill yields and interbank rates.
One-day changes in this money market spread around gilt announcements provide surprise information about overfunding, serving as the core identification device in a daily frequency structural vector autoregression.
This methodological approach allows for the decomposition of the portfolio balance channel into duration risk and local supply effects.
The study connects to the emerging empirical literature on quantitative tightening, which often grapples with the asymmetry of effects compared to quantitative easing, and draws parallels with other historical policy challenges illuminated by precedents like 'Operation Twist'.
Beyond symmetrical unwinds
This historical analysis provides crucial context for modern central banks navigating quantitative tightening.
It underscores that QT's channels can be exploited to calibrate aggregate effects, challenging the notion of simple symmetry with quantitative easing.
Policymakers can leverage these insights to fine-tune balance sheet unwinds, optimizing their impact on financial conditions.