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Queen’s Global MarketsA PREMIER UNDERGRADUATE THINK-TANK

Staying Ahead of the Curve

S. Aria, E. Merati, E. Urbankiewicz01.31.2019

Economic Slowdowns & Monetary Policy

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AgendaWhat we will be discussing today

1 Profile of a Recession

2 A Central Banker’s Toolkit: Interest Rates

3 A Central Banker’s Toolkit: Quantitative Easing

4 The Future of Monetary Policy

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What is a Recession? Slowdown vs. Recession vs. Depression

Leading Indicators Yield Curve –Relatively Flat

Profile of a RecessionUnderstanding the Enemy

Sources: BBC, The Economist, United Nations

• A period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters.

• Example: Great Recession which was 4 consecutive quarters of negative GDP growth (Last 2 of 2008 & first 2 of 2009)

• Recessions can begin quietly• National Bureau of Economic Research uses 5

factors (real GDP, income, employment, manufacturing, and retail sales)

• Shape of yield curve signals future outlook of the economy

• Plots rates with equal credit quality over time• A negative yield curve typically means 2-3

years before an official recession will occur

• There is no official definition of a depression, but think of it as an “extreme recession”

Sources: World Government Bonds, The Economist, Forbes

“When your neighbour loses his job, it is called an economic slowdown. When you lose your job, it is a recession. But when an economist loses his job, it

becomes a depression”

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A Central Banker’s Toolkit: Interest Rates

5Sources: BBC, The Economist, United Nations

Background Information

Financial institutions get directly affected

Rates go up based on customer risk profile (Prime)

Fed announces rate hike

Banks use this new rate (earnings increase)

Example – What Happens When The Target Rate Goes Up?

• The bank sets the target for the overnight rate, which is the interest rate at which major financial institutions (The Big 5) borrow or lend one-day funds among themselves

• The bank rate is the rate that the Bank of Canada lends to financial institutions (0.25% above target overnight rate)

Sources: Bank of Canada, Investopedia, The Canadian Encyclopedia

More foreign investors want to

buy Canadian Investments

Spend less, save more

Spend less, save more

Slow company growthStock market

decline

Bonds lose value

Overview of Interest Rates What is it? And what are the effects?

Govt debt increases

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Why do we use it anyway?Many benefits, but negatives as well.


Pros Cons

• The Bank of Canada is able to better effectively manage the business cycle and our inflation rate (1% - 3%)

• The Bank of Canada can act quickly to change the interest rate

• Independent of politics• Able to influence currency (low interest rate ->

weaker currency -> more exports)

• Due to the ripple effect, there is a time lag when the interest rates get implemented

• If interest rates are too low people will overspend and not be able to pay it back

• Limitation in rates of >0% (although some European banks have tried negative rates)

• No selection, affects the whole country

1954 – 2018 Federal Interest Rate Interest Rates & The 2008 Crisis

Sources: Investopedia, Foreign Affairs, Vox

• From Sept. 2007 to June 2008, the Fed cut interest rates, but then stopped as they worried about inflation

• The day after the Lehman Brothers went bankrupt, the Fed had a meeting and dropped rates from 2.64% to 1.98%

• Experts argue that when nominal GDP was falling, the Fed should have lowered interest rates a lot instead of keeping them high due to inflation concerns

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1

2

3

4

5

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2007-06-01 2008-06-01 2009-06-01 2010-06-01 2011-06-01

Fed Funds Rate Historical Chart (2007 - 2011)

Lehman Brothers Bankruptcy

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A Central Banker’s Toolkit: Quantitative Easing

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Open Market Operations


What is it?

• Open Market Operations is a tool used to inject an economy with “additional liquidity” when deflationary pressures rise

• Central Banks do so by purchasing government securities from the open market (namely from banks) and adding them to their balance sheets

• The additional capital provided by the central bank lowers interest rates, thus encouraging borrowing, consumption, and investing

Quantitative Easing in Practice

QE is “large-scale” Open Market Operations, and is considered an unconventional form of monetary policy

Sources: Google Images, Simone Aria

The Central Banker’s Toolkit


The Method Behind the Madness

The Federal Reserve “creates” electronic money to fund asset purchases

The new money is then used to buy government bonds from banks

Banks use the money to buy new assets – injecting funds into the economy and raising stock prices

The increased money supply pushes down interest rates further and encourages spending

Increased borrowing and investment raises aggregate demand and helps fight deflationary pressures

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Sources: Google Images, Singapore Management University, Simone Aria


Quantitative Easing

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Common Concerns Does it Even Work?

$14,000.

$15,000.

$16,000.

$17,000.

$18,000.

$500,000 $2,000,000 $3,500,000 $5,000,000

Rea

l GD

P (

$USD

bn)

Fed. Total Assets ($USD mm)


U.S. Real GDP vs. Federal Reserve Assets

• Overuse of QE can drive hyperinflation

• Encouraging capital flight to emerging markets• Can cause cost-push inflation instead of demand-

pull inflation• Banks may be too afraid to, or not have the

incentive to lend out additional money

$10,000

$13,000

$16,000

$19,000

$-

$1,000,000

$2,000,000

$3,000,000

$4,000,000

$5,000,000

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Real GDP ($USD bn) Fed. Total Assets ($USD mm)

The use of QE post 2008 recession has a moderate correlation with GDP levels. Without adjusting for the degree of influence from lowered rates however, the true impact of QE remains unclear.

R² = 0.725

Sources: Statista, Federal Reserve Bank of St. Louis


Quantitative Easing


Quantitative Tightening

Sources: The Wall Street Journal, Thomson Reuters, The Federal Reserve Bank of St. Louis

Federal Reserve

$3,800,000

$4,000,000

$4,200,000

$4,400,000

$4,600,000

2017 2017 2018 2018 2019

Total Assets ($USD mm)

$1,000,000

$2,000,000

$3,000,000

$4,000,000

$5,000,000

2012 2013 2014 2015 2016 2017 2018

Total Assets ($EUR mm)

The Federal Reserve has gradually began to de-lever its balance sheet, while the ECB reduces periodic bond purchases only slightly.

European Central Banks

• The Fed is shrinking their $4 trillion portfolio by allowing up to $50 billion worth of bonds to mature each month

• Despite concerns that the unwind is driving market volatility, long-term rates have gone down instead of up – reflecting sufficient demand for newly issued Treasury debt

• In the ECB, asset purchases peaked in 2016 – gradually falling up until the end of 2018 when it was announced that a Quantitative Tightening program would begin


Quantitative Easing – Taking a Step Back

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A Central Banks Toolkit:Other Forms of Unconventional

Monetary Policy

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Not the Sharpest Tools in The ShedForms of Unconventional Monetary Policy Being Considered Today

Top of Mind

More Abstract

Credit Easing Guidance

Negative Rates Long-Term Targeting

Helicopter Money Higher Inflation

FedCoin Asset Price Stabilization

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The Go-To OptionsMonetary Policy Tools That are Popular and Used by The Fed

Sources: : Bank Of Japan, Investopedia, St. Louis Fed

Credit Easing Guidance

Normal QE

Credit Easing

Government Bonds

Government Bonds +Private Sector Assets

Forward Guidance is Issued1

2

3

Investor Uncertainty Goes

Longer-Term Rates Go

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Ambitious AlternativesMonetary Policy Tools That are Being Considered or Used Worldwide


Negative Rates Long-Term Targeting

Sources: : Brookings Institution, Investopedia, FOMC

How This Works?

Is it Plausible?

What are the Issues?

• The Central Bank essentially sets a fee for banks that hold reserves above a threshold

• Banks will shift to other short-term assets, which drives down their yield

• To avoid negative returns, investors will turn to longer-term assets, lowering yield

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• Legal & Operational• Money Hoarding• Effects on MMF’s• Effects on Banks

How This Works?• The Central Bank essentially sets a peg (or

ceiling) for longer-term bond rates• Once the peg is set, the Central Bank will

then buy these securities in order to ensure that the price ceiling is contained

• Since price and yield are inversely related, reducing the amount of long-term bonds on the market will lower yield

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2

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Is it Plausible?• Importance of Timing:- The Central Bank must only purchase

bonds that mature at a certain date, rather than a certain time-frame

• Importance of Credibility:- If investors do not believe that the Central

Bank will hold the peg, they will sell all the securities to the Fed immediately

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0

5

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1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Per

cent

Real Effective Fed Funds Rate

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FedCoin Higher Inflation

Helicopter Money Asset Price Stabilization

Monetary Tools in the Shady ShedMonetary Policy Tools That Will Be Considered for the Future


How This Works?• “FedCoin” is a federally-backed blockchain

based digital coin replacing fiat currency

How This Works?• Increase in public spending or a tax cut

financed by an increase in the money stock Why Use It?• Direct effect of spending on GDP• Increase in household income from tax cut• Temporary increase in inflation• Money-finance program does not increase

future tax burdens

Why Use It?• Eliminates the lower bound problem• Direct control over the money supply

How This Works?• The Central Bank would create a higher

target inflation rate, increasing the difference between the nominal and real interest rate

Why Use It?• Larger difference between real and nominal

interest rate diminishes lower bound issue

How This Works?• The Central Bank would purchase or sell

equities or equity funds in order to stabilize asset prices, (such as the S&P 500)

• In nations where Central Banks are not legally permitted to purchases equities, sovereign wealth funds can be created to emulate the aforementioned duty

TroubleShooting

Sources: : Yale Law School, Brookings, The Economist, US Department of Treasury

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Questions?

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