Chapter 3 Macroeconomic Effects of Asset Purchase Programmes in a Monetary Union
3.5 Results
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3.5 Results
In this section, we conduct numerical analyses of macroeconomic effects of asset purchase program conducted by the central bank of monetary union. While this study intends to emphasize the policy’s effects in an asymmetric fiscal situation as stated above, in Section 3.5.1, we will conduct the analysis in a model with symmetric fiscal situation as most studies in the literature present. In the symmetric case, each structural parameter of countries H and F are identical, and is calibrated to the data of Germany and France, as the parameters reported in column (2) in Table 3.3. In Sections 3.5.2, we present the results in the asymmetric benchmark model with the first group of parameters to be asymmetric as presented in column (1) in Table 3.3.
3.5.1 The case of symmetric model
In the symmetric model, we will present the impact of the bond purchase plan on the yield spread and quality of long-term bonds in Section 3.5.1.1 and the macroeconomic effects of the policy in Section 3.5.1.2.
3.5.1.1 The yield spread and the quality of long-term bonds
This subsection examines how the unconventional monetary policy’s effects on the long-term yield spread between these two countries will differ with the relative quality of long-term bonds.
Subsection 3.1 reported that the yield spread across countries crucially relies on the weight of long-term bond purchases and the quality differential of long-term bonds across countries, as shown by Eq. (3.49). Given the symmectirc value of all coefficients including φξH , φξF , ξH, ΔH , ΔF
and others, in this subsection we simulate Eq. (3.49) to numerically show that the unconventional monetary policy’s effects on the long-term yield spread between countries H and F will differ with ξF.28 The difference between ξH and ξFdrives the relative quality of long-term bonds
28 Please note that, as shown by Eqs. (3.5) and (3.6), the long-term yield will be determined by the subjective discount factor and transaction cost. The transaction cost discrepancy will make the long-term yield unequal across countries.
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across countries and also implies the discrepancy in the debt-to-GDP ratio increases under the financial crisis.
Fig. 3.4 demonstrates the long-term yield spread across countries.29 It shows that, given the asset purchase plan with identical weights for the long-term bond purchases of these two countries(i.e., χ =0.5), as depicted by the solid curve, the long-term yield spread YSt across countries rises with the increase in the transaction cost ξF. As indicated in Eq. (3.48), a rise in the Foreign debt-to-GDP ratio in the steady state leads to an increase in the transaction cost of Foreign country ξF. Then, as displayed in the solid line, a rise in ξF is in association with a rise in the yield spread YSt. This negative relationship between YSt and ξF can explain that the decrease in the 10-year yield in IS is greater than that in GF following the PSPP policy’s implementation.
Furthermore, we can observe from the solid line that, for the equal shares of bonds purchased by the central bank (i.e., χ = 0.5), the Foreign yield is lower than the Home yield (i.e., ~L, < ~HL,t <0
t
F R
R ;
t 0
YS < ) when ξF >ξH. On the other hand, the effects of different asset purchase plans with different shares will result in different responses of the long-term yield spread to the policy. As exhibited in Fig. 3.4, when the share of Home bonds purchased increases from
χ
=0.5 toχ =0.6, the long-term yield spread declines in response. When the share of Home bonds purchased declines from χ =0.5 to
χ
=0.4, the reverse is true.[Insert Figure 3.4 here]
3.5.1.2 Macroeconomic effects of different bond purchase plans
In addition to the impact of bond purchases on yields, the focus of this study is on the macroeconomic effects of alternative asset purchase plans. In this subsection, we will examine the macroeconomic effects of alternative asset purchase plans under the circumstances where the Home and Foreign long-term yields are identical in the steady state.
29 The long-term yield in each country was characterized by the deviation from its steady state level in the first period after the policy shock.
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Two alternative asset purchase plans are considered. The baseline asset purchase plan involves purchasing the Home and Foreign assets in equal shares, corresponding to the country size, just as in the case of the implementation of the PSPP. The alternative asset purchase plan we consider imposes unequal shares on asset purchases, namely, 0.4 on the Home bonds and 0.6 on the Foreign bonds.
The results of the policy with equal shares of Home and Foreign bonds purchased (50% for each) are reported in Fig. 3.5.30 It is shown that these two countries have equal declines in the long-term yields and identical macroeconomic effects. Consistent with Chen et al. (2012), a fall in the long-term yields will stimulate the aggregate demand, and cause output and inflation to increase.
Moreover, according to the Taylor rule of the common monetary authority, higher inflation and output expansion leads the common monetary authority to push up the short-term interest rate.
[Insert Figure 3.5 here]
The responses of macroeconomic variables to an alternative policy are outlined in Fig. 3.6.
While fewer Home bonds are purchased (the share of Home bonds purchased by the central bank is lowered from χ = 0.5 to χ =0.4), the term premium and the long-term yield of the Home country decline less than those of the Foreign country.31 Thus, the expansionary effects of the policy on output, investment and consumption are smaller in the Home country than in the Foreign country. Note that the short-term interest rate rises because of inflation which may suppress the economic expansion, particularly through its effects on the consumption of unconstrained agents.
[Insert Figure 3.6 here]
30 We consider a situation in which, in period 1, the common monetary authority implements the PSPP shock.
31 Assume that the economy is in its steady state at the instant before the common monetary authority implements bond purchases. This implies that the term premium and the long-term yield in both countries are equal to zero at that instant of time.
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3.5.2 The case of asymmetric fiscal situation
This subsection will examine the macroeconomic effects of asset purchase plans under discrepant steady-state (pre-crisis) fiscal situation of country H and F, which are calibrated for the data of Germany and France for the low-debt country and Italy and Spain as the high-debt country respectively, as discussed in Section 3.4 and reported in column (1) of Table 3.3. We will evaluate the macroeconomic effects of the current PSPP in Section 3.5.2.1. In Section 3.5.2.2, we will propose an alternative asset purchase plan with different share of bond purchases and evaluate its effects, comparing with those under the current PSPP.
3.5.2.1 Macroeconomic effect of the PSPP for the Euro Area
We simulate the macroeconomic effects of unconventional monetary policies with equal shares.
Fig. 3.7 outlines the results. The long-term yield of the Home country with a lower initial long-term yield will decrease by less than that for the Foreign country which may have an expansionary effect on restricted consumption and investment. However, the union-wide inflation rises and results in an increase in the policy (short-term) rate which may reduce the consumption of unrestricted agents. As a result, for the Home country for which there is a smaller decline in the long-term yield and expansionary effect, the negative effect on the unrestricted consumption may dominate the positive effect on the restricted consumption and thus lead to the decline in aggregate consumption. A rising short-term rate may lead to an increase in the price of capital investment and suppress the investment after the first period. The consumption and investment contractions, however, result in only a temporary increase in the Home output, followed by declines right after.
On the other hand, for the Foreign country with a higher long-term yield, the long-term yield declines more after the policy is implemented. The expansionary effects of the decrease in the long-term yield dominate the negative effects of the short-term interest rate rise. Therefore, consumption, investment and output all rise in the Foreign country. The results show that the effects of the bond purchase plans may differ with the level of the initial long-term yield. The
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implementation of the PSPP with the share of bond purchases following the country size may have a smaller expansionary effect on countries with a lower long-term yield such as Germany and France than countries with a higher long-term yield such as Italy and Spain, and may have a smaller expansionary effect on the union-wide output.
[Insert Figure 3.7 here]
3.5.2.2 Counterfactual analyses: An alternative asset purchase plan
In this subsection, we will evaluate the macroeconomic effects of an alternative arrangement of the bond purchase program by changing the share of bonds purchased. Instead of purchasing equal shares of bonds from these two countries, we will let the common monetary authority purchase 40% of the Home country’s long-term bonds which have a lower yield, and 60% of the Foreign country’s long-term bonds which have a higher yield.
When compared with the results in Section 3.5.3, Fig. 3.8 shows that the alternative asset purchase plan will make the decline in the Home country’s long-term yield almost non-existent, but the Foreign country’s long-term yield will decrease more. The inflation rate rises more and thus the increase in the short-term interest rate is greater. As a result, the negative effect of the short-term interest rate rise dominates the positive effect of the long-term yield in the Home country where the consumption, investment and output each decline. On the other hand, the expansionary effects of the long-term yield are greater in the Foreign country, and thus the consumption, investment and output increase more than in the previous case. In sum, the counterfactual analysis shows that the alternative policy may result in greater economic expansion in the country with a higher yield, but may lead to an economic contraction in the country with a lower yield than in the previous case, thereby mimicking the PSPP. The union-wide effects of these two policies are shown in Fig. 3.9. The aggregate output and inflation of the monetary union rise more under the alternative policy.32
32 A more careful welfare analysis may be required to evaluate which policy performs better.