Pushing on a string: The effects of unconventional monetary policies on financial markets — Evidence from the United Kingdom

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Volume Title

School of Business | Master's thesis

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Date

2024

Department

Taloustieteen laitos

Major/Subject

Mcode

Degree programme

Economics

Language

en

Pages

94+9

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Abstract

Various central banks aggressively lowered their interest rates in response to the economic recession triggered by the 2007-2008 global financial crisis. The rate cuts failed to revive economic activity and boost inflation. As rates approached zero, central banks encountered limitations known as the zero lower bound and the liquidity trap, preventing them from decreasing the rates below zero. As historically low interest rates proved ineffective in stimulating economic activity, central banks introduced unconventional monetary policies of forward guidance and quantitative easing to stimulate low economic activity. This thesis examines how the Bank of England's unconventional monetary policies of quantitative easing and forward guidance influenced financial markets after the 2007-2008 global financial crisis. The study's time horizon extends to 2023 and encompasses Brexit and the Covid-19 pandemic. An empirical analysis using regression analysis and an event study framework by Urbschat and Watzka (2019) is employed to measure the effectiveness of these policies on long-term bond yields and identify asset price channel variables, namely liquidity, credit risk, signaling, and portfolio rebalancing channels. This paper finds that unconventional monetary policies did not achieve their intended effects of reducing bond yields, risk-free rates, bond spreads, or enhancing liquidity to increase credit and real economic activity. Additionally, these policies failed to decrease credit risks, as indicated by occasional increases in credit default swap premia, suggesting heightened risk aversion and market segmentation. Calm financial market conditions and low baseline policy rates likely contributed to these muted responses. The findings indicate that monetary policies might be less effective overall under calm financial market conditions. They highlight the need for ongoing research to assist central banks in formulating policies that respond effectively to periods of low economic activity and promote stability and growth.

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Thesis advisor

Honkapohja, Seppo

Keywords

central banks, unconventional monetary policy, interest rates, financial markets

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Citation

Permanent link to this item

https://urn.fi/URN:NBN:fi:aalto-202406164322

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[gradu] Kauppakorkeakoulu / BIZ