Riksbanken: Lower liquidity will not affect financial stability

sep. 19, 2016

Will there ever be a life after quantitative easing, QE? Yes, said Martin Flodén, Deputy Governor of the Riksbank, in a discussion panel at Swedish House of Finance Conference on Credit Markets after the crisis.

“Though I think it will take many years before the stocks that have been accumulated are abolished in some way”, he added.

How long it will take to get there, and what life after QE will be like, were two interesting questions with less obvious answers.

Martin Flodén explained that Riksbanken have analysed the effects of its asset purchasing, and found that QE has had no obvious effects on market liquidity. The lower liquidity that we see today is more likely caused by changes to regulations, such as changed capital requirements, he argued. So when Riksbanken stops purchasing assets, it is unlikely that it will have a clear impact on market liquidity, Martin Flodén concluded.

He also discussed whether lower liquidity is really a problem.

“It can affect efficiency of markets. But in terms of financial stability, I don’t think that lower liquidity needs to be a problem. The problem is more if liquidity disappears. So, given that this is a slow, permanent and understood change to markets – I don’t think it affects financial stability directly”, said Martin Flodén.

Lack of Transparency in QE

Anna Öster, chief economist at Länsförsäkringar, pointed out that the lack of transparency in Riksbanken’s quantitative easing can be a problem. What happens if Riksbanken’s QE stops at the end of 2016, as Riksbanken have said – but ECB change their course and continue their QE after March 2017.

“Can we just be relaxed in that situation and say that it’s okay that the krona strengthens? Or do we have to keep up with the ECB? And if we do think that we have to keep up, what are we going to do? I think this is the most pressing issue for you to be more clear on.”

Although the governor of Riksbanken has said that Riksbanken can buy the whole amount of outstanding debt, Anna Öster argued that the market does not believe that Riksbanken wants to do this.

“Are you going to buy mortage debt? Or are you closer to currency interventions?”

We are in a new situation with monetary policy, Anna Öster continued.

“We don’t know where we are going to end up and we don’t know the effects on the market. We need more details of what you really think of QE. If the market thinks you are out of tools, that can be a problem – even if you are not”.

“Didn’t Know How It Would Work”

Martin Flodén agreed that Riksbanken have not been very transparent about their QE for the last couple of years, and explained that there are several reasons for this – one being that Riksbanken have chosen to do the QE in six small steps, evaluating the effects along the way.

“We announced the program in five steps because we didn’t know how it would work. If we had known it would work so well, we could have announced it all in February 2015 when we started. But we didn’t know. And we still don’t know – how far can we cut the repo rate?”.

Anna Öster also criticized the fact that Riksbanken didn’t do more, faster, when they started lowering the repo rate.

“If you had done things differently, maybe you wouldn’t have had to go to these extremes”, she said.

Martin Flodén agreed with her assessment:

“We could have done more earlier – we should have done more earlier.”

ECB: EQ has supported growth

Luc Laeven, Director-General at Directorate General Research at the European Central Bank, ECB, explained that the general view of ECB is that QE has reduced the risk of deflation and supported growth.

He went on to address the issue of how QE is affecting bank profitability, concluding that there are both positive and negative effects, mentioning a flattening yield curve and holding costs, but also capital gains on securities portfolios and lower loan charge offs due to improvements in credit quality. Hence different banks were affected differently depending on the structure of their balance sheets.

Transformation of Money Markets in the US

Gary Gorton, Professor of Finance at the Yale School of Management, went on to explain that the situation in the US is different – not ahead of Europe, he clarified, just different. The Federal Reserve Bank’s quantitative easing strategies have altered the infrastructure of the money market, he stated.

“What the long term impact on the infrastructure of the money market is going to be, we have yet to see. Over some period of time, it’s going to completely alter what money markets even are.”