March 12, 2018

The dog that did not bark

The ECB announces the end of the extraordinary monetary policies: the markets do not make a move, as does the spread. What if the quantitative easing has not been a “protective shield” for Italy then? What if it only contributed to change the composition of the Italian public debt, with only temporary effects on the risk premium? Doubts and non-mainstream clues

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The end is in sight. The President of the ECB, Mario Draghi announced on March 8 that the program of government bond buying which the ECB had initiated almost exactly 3 years earlier will most probably end towards the end of this year.  However, this announcement did not lead to a sizeable market reaction.  This lack of a reaction is particularly interesting for the Italian debt market given that only a few days earlier the national election had given rise to a strong showing of euro-skeptic parties and a hung parliament.  It had often been argued that the bond buying of the ECB constituted a key protection for the Italian government debt market.
However, one can see quickly that the ECB never provided a ‘shield’ for Italy if one looks closer the PSPP (Public Sector Purchase Program, the technical name of the bond buying program of the ECB).  Under the PSPP is not the ECB, which buys government debt, but only the national central banks of the euro area.  Only the Bundesbank buys Bunds and only the Banca d’Italia buys BTPs.  Moreover, there is no risk sharing. This implies that all the profits (and potential losses) on BTPs would fall only the Banca d’Italia.
But the Banca d’Italia is part of the Italian public sector.  When the Banca d’Italia buys BTPs it is as if the subsidiary of a large holding buys the debt of the mother company.  The overall debt of the entire entity does not change.  When the Banca d’Italia buys BTPs the overall debt of the public sector in Italy does not change, only the composition does: there will be fewer BTPs available for the public, but more deposits at the Banca d’Italia (or larger Targe2 balances), which constitute effectively short term government debt.
The main effect of the PSPP of the ECB has thus been to shorten the maturities of national public debt in euro area countries.
It is often argued that having a substantial part of the public debt in the hands of the national central bank offers a protection against speculative attacks.  This might an important consideration in light of the financial crisis of 2011/2.  But one has to keep that if there are fewer BTPs in the hand of the public, a higher hair cut would have to be imposed in the (highly unlikely) case that a restructuring of Italian debt were to become necessary.  The PSPP should have made public debt safer from speculative attack, but if one were to occur nevertheless, the losses would be higher.  But this implies that the bond buying by the Banca d’Italia did not necessarily cause a reduction in the risk premium.  This insight can explain why the announcement of the end of QE did not result in a higher risk premium.
The impression that the QE of the ECB is important comes from a series of academic studies, which show that the announcement of the PSPP coincided with reductions in some interest rates and risk premia. However, close inspection of the data shows that these effects were temporary and had dissipated a few months after the start of the actual bond buying.
It follows that the importance of Quantitative Easing in the euro area has been vastly exaggerated. The end of central bank bond purchases in the euro area should be a ‘non-event’.

The author

Daniel Gros

Daniel Gros is Director of the Centre for European Policy Studies (CEPS), Senior Fellow of LUISS School of European Political Economy and Member of the Advisory Board of The LUISS Center of Italian Mezzogiorno Studies


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