Bond Markets and Unconventional Monetary Policy

Abstract

This paper is a comprehensive study of the discussion and empirical evidence about the impact of unconventional monetary policy on bond markets. The 2007/2008 Financial Crisis marks the beginning of a new monetary policy regime in which central banks engaged in different types of large scale asset purchases. These decisions were unconventional with respect to the previous policy of targeting a short term interest rate. In this paper, we begin by comparing different measures adopted by the Federal Reserve, the European Central Bank, and the Bank of England. Next, we discuss (current) theoretical arguments through which unconventional policy (large scale asset purchases) might affect interest rates: (a) Portfolio Balance (duration) channel; (b) Credit and capital constraint channel; and (c) Preferred-habitat and Asset Scarcity channel. Finally, we review the empirical evidence in support of each channel using data from both Treasury and Mortgage-backed security markets. We distinguish two methodological approaches. The first is based on high-frequency data during the time surrounding specific LSAP event dates. The second approach uses low-frequency data and considers information beyond a narrowly defined event window. This allows us to distinguish short-term and long-term effect of different sets of unconventional measures.

Keywords: Interest Rates, Monetary Policy, Quantitative Easing, LSAPs, Financial Crisis

JEL Classification: E43, E44, E50, E51, E52, E58