V Flashcards
Bondsand Interest Rates, Digital and Decentralized Finance
Free markets to Fed markets: How modern monetary policy impacts equity markets
Putnins, Talis J., 2022
Stock markets generally reflect the health and expected future health of the underlying real economy. Explain in what sense did stock markets appear to become disconnected from the real economy during COVID-19. And what were the key drivers of the disconnect?
When central banks intervene, positive correlation between the stock market and the future health of the economy breaks down and could even become negative because of the counter cyclicality of the central bank’s actions—expansionary monetary stimulus putting upward pressure on stock prices during periods of deteriorating economic outlook. The increased magnitude of central bank intervention amplifies these effects leading to a greater divergence between stock markets and the real economy.
Free markets to Fed markets: How modern monetary policy impacts equity markets
Putnins, Talis J., 2022
How did large central banks such as the US Federal Reserve respond to falling stock prices during COVID-19 and what are the channels through which the Fed’s actions impacted stock prices?
Response of aggressive balance sheet expansion (the FED).
Long-term bond yields: which tend to fall when the Fed buys fixed income securities, reducing the discount rate for equities and increasing stock prices.
The Fed’s actions impact expected future macroeconomic conditions and thereby expected future corporate earnings.
Free markets to Fed markets: How modern monetary policy impacts equity markets
Putnins, Talis J., 2022
In June 2022 global stock markets “crashed” according to market commentators. The key trigger, according to media, is expected actions of the US Central Bank, the Fed. For example, Bloomberg reports “Stock Traders Coming to Grips With a Fed as Baffled as They Are The S&P 500 lost 3.3% to trade at its lowest level since the end of 2020 speaks to the chaos gripping markets of late. The Nasdaq 100 was down 4% Thursday. Bonds, Bitcoin, every sector in the S&P 500 dropped – little was spared”. According to the reading what may have triggered the market crash?
???? decline in FED’s BS???
Free markets to Fed markets: How modern monetary policy impacts equity markets
Putnins, Talis J., 2022
Explain the asymmetries in how the Fed manages its balance sheet and the asymmetries in the relations between the stock market and the Fed’s actions.
Free markets to Fed markets: How modern monetary policy impacts equity markets
Putnins, Talis J., 2022
Explain the channels through which the Fed’s actions impact stock prices.
Long-term bond yields: which tend to fall when the Fed buys fixed income securities, reducing the discount rate for equities and increasing stock prices.
The Fed’s actions impact expected future macroeconomic conditions and thereby expected future corporate earnings.
Free markets to Fed markets: How modern monetary policy impacts equity markets
Putnins, Talis J., 2022
Why does the reading believe that markets have disconnected from the economy?
Despite the deteriorating economic conditions of the
pandemic, the US S&P500 has increased by 31% from
March 23, 2020 during the two months taking it back to
the levels prior to COVID-19 outbreak.
Free markets to Fed markets: How modern monetary policy impacts equity markets
Putnins, Talis J., 2022
What are believed drivers of the disconnection between economy and the stock markets?
Counter cyclicality of the central bank’s actions—expansionary monetary stimulus putting upward pressure on stock prices during periods of deteriorating economic outlook. The increased magnitude of central bank intervention amplifies these effects leading to a greater divergence between stock markets and the real economy.
Free markets to Fed markets: How modern monetary policy impacts equity markets
Putnins, Talis J., 2022
What is the reaction of a stock market to the FED’s balance sheet changes and vis-a-verse?
Negative lagged correlation is consistent with the
FED reacting to negative stock returns, or bad
economic outlook by expanding its BS.
Positive correlation being consistent with the idea that the stock market reacts positively to FED’s BS expansion.
Free markets to Fed markets: How modern monetary policy impacts equity markets
Putnins, Talis J., 2022
What are the channels through which the FED’s Asset Purchasing programmes might have impacted the stock market movements?
The two major channels:
● Impact on long-term bond yields: FED’s QE in response to the GFC resulted in long-lasting reduction in longer-term interest rates.
● Impact on future health of the economy: QE is likely to have a positive impact on future economic conditions, using wealth effects (QE inflated stock prices), credit channels (lower interest rates i.e. more accessible borrowing).
Additionally, scope of the Asset Purchasing Programme during COVID: if FED has limited itself only to treasury or fixed income markets, their impact on stock markets would be limited to these classes, due to limited spillover effects. However, the FED’s willing to do “Whatever it takes’’ to avoid stock market collapse has signaled it could directly intervene in the market to buy equities (through ETFs). This signal sent by FED may have provided an additional positive shock to equities.
Free markets to Fed markets: How modern monetary policy impacts equity markets
Putnins, Talis J., 2022
What is QE?
Quantitative easing is a monetary policy action whereby a central bank purchases predetermined amounts of government bonds or other financial assets in order to stimulate economic activity.
Free markets to Fed markets: How modern monetary policy impacts equity markets
Putnins, Talis J., 2022
What are the two main channels for how the Fed’s intervention in fixed income markets impacts stock markets?
Long-term bond yields: which tend to fall when the Fed buys fixed income securities, reducing the discount rate for equities and increasing stock prices.
The Fed’s actions impact expected future macroeconomic conditions and thereby expected future corporate earnings.
Free markets to Fed markets: How modern monetary policy impacts equity markets
Putnins, Talis J., 2022
Free markets to Fed markets: How modern monetary policy impacts equity markets
Putnins, Talis J., 2022
Free markets to Fed markets: How modern monetary policy impacts equity markets
Putnins, Talis J., 2022
Is there a zero lower bound? The effects of negative policy rates on banks and firms
Altavilla, Carlo, Lorenzo Burlon, Mariassunta Giannetti, and Sarah Holton, 2022
Interest rates are near zero or even well below zero in many countries right now. For example, the ECB key policy rate (deposit facility rate) is negative and current Eurozone yield curve showing negative yields at horizons out to 15 years.
The issues that arise in these circumstances, in particular the concerns that conventional monetary policy may become ineffective, are discussed in the article “Is there a zero lower bound? The effects of negative policy rates on banks and firms”.
Is conventional monetary policy effective when interest rates are below zero - explain the theoretical reasons or arguments why it might or might not be effective. Then discuss the recent evidence about the effectiveness of conventional monetary policy when rates are
negative compared to when rates hover around zero and when rates are positive.
Is there a zero lower bound? The effects of negative policy rates on banks and firms
Altavilla, Carlo, Lorenzo Burlon, Mariassunta Giannetti, and Sarah Holton, 2022
Explain the corporate channel of monetary policy in a negative interest rate environment.
Is there a zero lower bound? The effects of negative policy rates on banks and firms
Altavilla, Carlo, Lorenzo Burlon, Mariassunta Giannetti, and Sarah Holton, 2022
What are the problems of low interest rates?
Macroeconomic problems (zero lower bound).
When the interest rates are low and the economy is in liquidity trap (i.e. monetary policy is severely limited), banks cannot lower the deposit rate. If they do so, their clients will just start hoarding (storing for themselves, out of the bank) the paper money. However, this would severely affect banks because big part of their BS comprises of deposits.
Negative interest rate policies
Negative rates reduce banks’ profits and lead banks to reduce lending. However, it could work if there was particular mechanism to increase the costs of hoarding paper currency.
Is there a zero lower bound? The effects of negative policy rates on banks and firms
Altavilla, Carlo, Lorenzo Burlon, Mariassunta Giannetti, and Sarah Holton, 2022
What is the zero lower bound (ZLB)?
A belief that interest rates cannot fall below zero.
Is there a zero lower bound? The effects of negative policy rates on banks and firms
Altavilla, Carlo, Lorenzo Burlon, Mariassunta Giannetti, and Sarah Holton, 2022
What “liquidity trap”?
A liquidity trap is an adverse economic situation that can occur when consumers and investors hoard cash rather than spending or investing it even when interest rates are low.
Is there a zero lower bound? The effects of negative policy rates on banks and firms
Altavilla, Carlo, Lorenzo Burlon, Mariassunta Giannetti, and Sarah Holton, 2022
Is is unclear how and which investors are affected by negative interest rate environment. How do the effects vary if the rate cut happens above, around and under the ZLB?
When the cut is happening and rates still remain above the ZLB, banks pass on most of the policy rate cuts within 12 months.
When the cut is happening and rates still remain around ZLB, there is little pass through even after a year of only 20% of the original cut is reflected. This supports hard ZLB - concentration around 0%.
When cut happens and rates pass the ZLB, pass through
increases but only for financial sound banks. ZLB stops being temporary policy.
Is there a zero lower bound? The effects of negative policy rates on banks and firms
Altavilla, Carlo, Lorenzo Burlon, Mariassunta Giannetti, and Sarah Holton, 2022
What is monetary policy transmission?
How much of the interest rate cut is passed through to corporate deposit.
Is there a zero lower bound? The effects of negative policy rates on banks and firms
Altavilla, Carlo, Lorenzo Burlon, Mariassunta Giannetti, and Sarah Holton, 2022
What is NIRP?
Negative interest rate policy.
Is there a zero lower bound? The effects of negative policy rates on banks and firms
Altavilla, Carlo, Lorenzo Burlon, Mariassunta Giannetti, and Sarah Holton, 2022
Safe banks, may have particularly strong market power when weak economies require NIRP. This is because firms often deposit the cash in banks whose deposits have high ratings => firms have a demand for safe assets.
Due to such market power, on average the banks in non-stressed countries are more likely to charge
negative rates on corporate deposits.
Is there a zero lower bound? The effects of negative policy rates on banks and firms
Altavilla, Carlo, Lorenzo Burlon, Mariassunta Giannetti, and Sarah Holton, 2022
How does the excess liquidity affect banks’ profits when interest rate drops?
The profits of banks with high excess liquidity are more negatively affected when the interest rate drops, as these banks are more likely to impose negative rates.
Is there a zero lower bound? The effects of negative policy rates on banks and firms
Altavilla, Carlo, Lorenzo Burlon, Mariassunta Giannetti, and Sarah Holton, 2022
Why banks do not experience large deposit outflows when they implement negative rates?
!!!!!wtf
Deposit growth is higher after banks start imposing negative rates on deposits. And weak banks experience lower deposit growth in the first months.
Is there a zero lower bound? The effects of negative policy rates on banks and firms
Altavilla, Carlo, Lorenzo Burlon, Mariassunta Giannetti, and Sarah Holton, 2022
Corporate channel of monetary policy
Since negative rates increase the cost of holding cash, this discourages the corporate savings glut. Ultimately, the firms rebalance their assets and spend cash to expand their investments i.e. promote economic growth.
Firms associated with banks who charge negative rates and are more exposed to negative rates via higher liquidity experience higher fixed asset growth and decrease in liquidity. The effect is even stronger for smaller firms, as they highly rely on the relationship with bank for credit.
● Firms with high liquidity experience a small drop in profitability in the year in which their bank starts to charge negative rates, they increase investment and the investments start to pay off. Before NIRP firms hoarded liquidity and applied too high discount rates to investment.
