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|Title||Exiting Quantitative Easing: Are there Spillover Effects?|
|Institution||University of Zurich|
|Faculty||Faculty of Business, Economics and Informatics|
|Number of Pages||73|
|Zusammenfassung||In the aftermath of the recent financial crisis the Federal Reserve System, the Bank of England, the European Central Bank, and the Bank of Japan all made use of unconventional monetary policy instruments in order to ensure a certain market functioning and to stimulate the economy. These instruments mostly entailed asset purchases and/or the establishment of lending systems towards certain market participants and were used after conventional instruments such as the policy rate due to hitting its lower bound became ineffective. However, at some point all of these programs were financed by the issuance of reserves. This can be problematic as these reserves are initially part of the economy’s base money, but over the inverse relationship between interest rates and money could be easily transferred into the money supply potentially causing a large and disrupting inflation once interest rates begin rising. As these programs have been in place over many years and the respective reserves balances grew considerably the question arose what effects an exit from these policies could have on the economy. Naturally, the follow-up question evolved whether there exists an optimal timing and/or an optimal strategy for each economy to exit these policies in response to these effects. However, my thesis not only aims to elicit these optimal exiting timings and strategies, but also aims to find out whether these choices change in response to potential spillover effects of other economies exiting, too. In order to tackle these questions I first build a theoretical framework in order to model how an exit could potentially affect the for central banks relevant economic variables inflation and output. I extended this isolated view in order to account for spillover effects by allowing foreign monetary policy instruments to affect the domestic economy. From that point I employed an empirical model building on the approach of Hayashi and Koeda (2017), which incorporated my theoretical implications. In this model the economy can either be in a conventional state in which it operates with its conventional monetary policy instruments or in an unconventional state in which it employs unconventional instruments. Depending on past states and current variable realizations the system is able to endogenously switch regimes if certain conditions are met. However, as no central bank has exited the recent unconventional policies yet I programmed a 24 months' simulation starting from December 2016 of how an «exiting shock» would affect inflation and output based on the estimated model coefficients and the underlying data. The simulation was conducted in a way that I programmed 500 combinations of two paths A and B of the monthly inflation, the monthly output gap, the policy rate, and the excess reserves rate as one single process exhibited a lot of variability. The paths were identical up to the month t in which I shocked the model by exogenously applying a change in states from the unconventional state to the conventional state This not only entailed a change in the applying policy rate, but also a change in the excess reserves determination. From t+1 onwards I allowed for complete flexibility of both paths to operate according to the model’s working mechanism enabling the possibility of both paths to endogenously switch states in the future given the according conditions are met. The difference in these paths was then interpreted as the effect of the «exiting shock» with which the economy was hit in time t and can be best thought of as a generalized impulse response function. From an isolated perspective all economies were advised not to exit the unconventional regimes. The reason for this was that neither the shocked nor the unshocked path were able to achieve a sustainable exit due to a combination of the estimated coefficients, the working mechanism of the model, and the underlying data. Exiting attempts only caused either volatility in output and inflation such as in the US, the UK, and the Euro Area or lasting adverse effects as in the case of Japan. Broadening the view to an integrated perspective already changed these optimal strategies considerably. Furthermore, I found that foreign policy measures spilled over to the other economies in a way that they shaped the magnitude of the average exiting shock pattern as well as the average pattern itself further altering the optimal exiting timing and the optimal exiting strategy for the US, the Euro Area and for Japan while the UK was still advised to stick to the isolated strategy of not exiting as its economy was estimated to be unable to exit sustainably in any constellation of the integrated perspective. The other three economies were advised to exit the regime only by slowly increasing the policy rate while slowly decreasing the excess reserves rate in order to minimize the volatilities arising from an exit and in order to shield themselves as good as possible from the spillover effects that the other economies caused. This was enforced by advising the economies to make use of additional policy instruments such as interest rate floors. The optimal exiting timing for the US was found to be as soon as possible unless the Euro Area exits, which would lead to an average delay of four months. Due to domestic factors the Euro Area and Japan were advised to exit earliest by the end of 2018 and mid 2019, respectively. However, as certain limitations such as constant coefficients and parameters as well as simplifying assumptions were inherent to this thesis I hope that future research can overcome these hurdles.|