Photographer: Andrew Harrer/Bloomberg

BIS Study Casts Doubt on ‘Ultimate Effectiveness’ of QE

  • Easy money shown to tame market volatility, risk premia
  • But post-crisis this had no ‘significant impact’ on growth

Central banks might have a problem with their policies, according to their bank.

A working paper by the Bank for International Settlements found cuts in interest rates and asset purchase programs can help reduce volatility in stocks and bonds and dampen the so-called term premium, or the additional compensation investors receive for holding longer-term government debt.

But it also found a watershed may have emerged following the financial crisis: Unlike pre-2008, reducing the term premium doesn’t appear to spark economic growth.

“While conventional monetary policy easing boosts economic activity pre-crisis, unconventional monetary policy post-crisis is found to have no statistically significant real impact, despite having a sizeable negative effect on the term premium,” wrote BIS researchers Sushanta Mallick, M. S. Mohanty and Fabrizio Zampolli. “This finding, which is still preliminary and needs to be confirmed by further analysis, casts some doubt on the ultimate effectiveness of quantitative easing in the U.S.”

And there’s another big difference between pre- and post-crisis.

Before 2008, a sharp rise in the CBOE Volatility Index -- a measure of implied volatility calculated from what investors pay for options on the S&P 500 stocks index -- typically spread to bonds and sparked a jump in the term premium and a subsequent decline in economic activity.

To see the Trump effect on term premia, click here.

More recently a jump in the VIX, as it is known, has been accompanied by a decline in the term premium, “suggesting the prevalence of flight to quality effects,” according to the paper published Tuesday. In other words, as investors flee stocks and rush into longer-term government debt.

The VIX’s relevance in the aftermath of the financial crisis and unprecedented monetary easing has emerged as a key area of study for academics including Hyun Song Shin, head of research at the BIS. He’s argued the greenback’s role as a global funding currency makes the dollar index a better indicator of market risk appetite and leverage levels.

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