Monetary policies: breaking out the unconventional weapons
Ever since the bankruptcy of Lehman Brothers in 2008, the major central banks have expanded their actions to include "unconventional" monetary policies.
In the summer of 2007, the major central banks began to inject vast quantities of liquidity into the financial system in order to compensate for the failure of the interbank market. They cut their key interest rates to the point where they reached or approached the 'zero level' plateau. From late 2008, they adopted new methods of monetary easing that massively increased the size of their balance sheets. These policies had two objectives: to stabilise financial markets and, once short-term interest rates fall below the zero level, to introduce additional stimulus.
The major central banks have made use of three main categories of unconventional measures:
- quantitative easing
- credit easing
- managing market players' expectations.
Quantitative easing consists of setting quantitative objectives regarding the desired level of surplus reserves for commercial banks. The goal is to increase the central bank's liabilities and thus the monetary base.
The goal of credit easing is to unfreeze credit markets by altering the composition of the assets on the central bank's balance sheet, which is generally made up of government bonds, by directly acquiring private debt instruments.
The central bank may also try to steer market players' expectations on future interest rates by committing to a future path for its key interest rate. The aim here would be to lower long-term rates.