Module VII·Article V·~3 min read
Unconventional Monetary Policy: QE and Negative Interest Rates
Money Supply and Monetary Policy
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Unconventional Monetary Policy
The Global Financial Crisis of 2008 and the subsequent period led to the widespread adoption of unconventional monetary policy tools. When interest rates reached the zero lower bound (Zero Lower Bound, ZLB), central banks were forced to seek alternative ways to stimulate the economy. Quantitative easing (QE), negative interest rates, and yield curve control became part of the standard arsenal of monetary policy.
Quantitative Easing (QE)
Quantitative easing is the purchase of financial assets (usually government bonds) by the central bank with the aim of increasing the monetary base and lowering long-term interest rates. Unlike traditional management of short-term rates, QE directly affects the long-term segment of the yield curve. The mechanisms of QE’s impact are diverse.
The portfolio effect consists in the fact that investors who sold bonds to the central bank reallocate funds into other assets (corporate bonds, stocks), thereby lowering risk premiums. The signaling effect communicates to the market the central bank’s intention to keep rates low for a long time.
The Federal Reserve carried out three rounds of QE: QE1 (2008-2010), QE2 (2010-2011), QE3 (2012-2014), growing its balance sheet to about $4.5 trillion. The European Central Bank launched a large-scale asset purchase program in 2015, expanding it to €2.6 trillion. The Bank of Japan has practiced QE since 2001 with interruptions.
Negative Interest Rates
Negative interest rates once seemed theoretically impossible—why pay to lend money when one could simply hold cash? Nevertheless, a number of central banks (ECB, Bank of Japan, Swiss National Bank, Riksbank, National Bank of Denmark) introduced negative rates on bank deposits held at the central bank.
Negative rates work because storing large volumes of cash is expensive and risky. Banks, large corporations, and institutional investors cannot simply convert trillions into banknotes. They are forced to accept negative yields as the lesser evil.
The objective of negative rates is to stimulate banks to lend instead of holding reserves at the central bank, weaken the national currency to support exports, and demonstrate a willingness for further easing.
Yield Curve Control (YCC)
Yield Curve Control is a policy whereby the central bank commits to buying or selling unlimited amounts of bonds to maintain a target yield. In contrast to QE with a fixed purchase volume, YCC fixes the price, allowing the quantity to be determined by market conditions.
The Bank of Japan introduced YCC in 2016, targeting a 10-year yield near zero. The Reserve Bank of Australia (RBA) used YCC on 3-year bonds in 2020-2021. The Fed discussed but did not implement YCC.
YCC can be more effective than QE in certain circumstances. If the market believes in the central bank's commitment to the target, intervention may not be necessary—expectations alone will keep yields near the target. However, exiting YCC can be painful if conditions change.
Effectiveness and Side Effects
Assessments of QE's effectiveness are ambiguous. Research shows that QE1 in the US lowered long-term rates by 50-100 basis points. Subsequent rounds had a lesser effect—diminishing marginal returns.
Side effects include: increasing inequality (QE lifts asset prices, which are primarily owned by the wealthy); distorting price formation (yields do not reflect real risks); risks to financial stability (the search for yield pushes investors toward riskier assets); and challenges in normalization (balance sheet reduction may destabilize markets).
Investment Implications
Unconventional policy has created a "new normal" for investors. Low rates have compressed bond yields, forcing the search for yield in riskier asset classes. This has supported high valuations of stocks and real estate, but has created vulnerability to policy normalization.
The exit from QE (tapering) and rate hikes create risks for long bonds and rate-sensitive sectors. The "taper tantrum" of 2013 showed how even the hint of QE reduction can trigger sell-offs.
Investors should account for their position within the monetary cycle. In the tightening phase, short durations, floating rates, and beneficiaries of higher rates (banks) are attractive. In the easing phase—long bonds, dividend stocks, and real estate.
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