17 Dec 2018
In my January 2016 investment letter, I wrote about some interesting but little-heard-of research by Dr Leo Krippner at the Reserve Bank of New Zealand on the subject of quantitative easing. It was therefore nice to see that he had received a Central Banking Award for Economics last year in relation to this work1.
I had trouble understanding the detail of Krippner’s research myself but, to put it as simply as possible, he used bond option pricing techniques to represent quantitative easing (QE) in terms of an effective central bank policy rate, his so- called ‘shadow short rate’ (SSR). QE is required when interest rates hit the zero lower bound (ZLB) since negative rates would result in a flight from bank deposits into better (zero) yielding physical currency. The QE that followed the Great Financial Crisis (GFC) was simply what was required to loosen monetary policy even further, given that the zero interest rate was still too tight. This essentially represented a shift from setting the price of money (interest rates) to setting the quantity of money (QE). Looked at in this way, it makes sense that QE can be represented as a hypothetical (negative) policy rate that would be in place if physical currency did not exist and thus there was no need for QE.