09 September 2016

ECB working paper: Net debt supply shocks in the euro area and the implications for QE

Authors examine the likely effects of ECB government bond purchases on euro area interest rates and show how changes in the amount of government bonds have affected debt-weighted government bond yields historically and how these changes have spilled over into economic activity and consumer prices.

Because the European Central Bank (ECB) in the past never purchased government bonds as part of its regular monetary policy operations, authors construct a new measure of the “free-float” of government bonds in the euro area, which weights together the amount of outstanding debt by its maturity structure and subtracts bonds that are held by overseas official institutions like central banks and sovereign wealth funds. These institutions are a major player in euro area bond markets: they are the single largest investor group in some key segments of the euro area government bond market and are currently estimated to hold around 15% of the total outstanding stock of euro area debt. The reason that these bonds are excluded is that purchases by foreign central banks or by the ECB can be thought of as having similar effects on euro area interest rates.

Their analysis finds that by reducing the amount of bonds available to private investors, purchases of bonds by official institutions put downward pressure on euro area government bond yields. Lower interest rates, in turn, stimulate economic activity and put upward pressure on consumer prices. They use these past regularities between the effective supply of bonds and yields to simulate the impact of the ECB’s public sector purchase programme (PSPP) on both the euro area yield curve and the macroeconomy.

Taking into account the size of the programme and the envisaged split of purchases between short- and long-term bonds, authors estimate that the PSPP, as announced in January 2015, may have reduced euro area long-term yields, on average, by as much as 30bps in 2015 and raised the output gap and inflation by some 0.2ppt and 0.3ppt respectively in 2016. Importantly, these estimates are likely to underestimate the overall impact of the ECB’s purchases on interest rates as they exclude effects on credit risk and monetary policy expectations that are likely to have compressed interest rates even further. Moreover, their analysis does not take into account the extension of the intended horizon of the APP to March 2017, announced in December 2015, or the expansion in the monthly volume of APP purchases, announced in March 2016.

Working paper

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