Daniela Gabor at UWE tweeted an interesting article on Reuters describing troubles in money markets due to a ‘shortage’ of high quality sovereign bonds in the Eurozone. The proximate cause is the launch of the ECB’s quantitative easing program. The cause of that being the persistent below target inflation and depressed real activity. And the cause of that being a GLUT of sovereign bonds. A shortage ultimately caused by a glut?! This it not necessarily a contradiction, since the glut would correspond to lower quality bonds issued in desperation.
A few observations.
1. Depending on how you view the transmission of QE, it’s partly a feature and not a bug to create such shortages, so that market participants switch to using private sector assets as a substitute, bidding up the price of those assets, lowering the cost of funding for and stimulating spending by the issuer.
2. But for activities involving private sector market players only, there could be painful, perhaps insurmountable obstacles to switching from an equilibrium in which everyone uses sovereigns as collateral for everything, to one in which private sector assets do the job. There have been glimmers of this before, in econometric evidence showing that QE lowers government yields, but leaves private yields less affected.
4. For transactions involving the central banks themselves, the obvious solution is to combine QE with a relaxation of collateral requirements to embrace riskier private sector assets on less disadvantageous terms. The ECB was anyway inclined towards credit easing [taking private sector assets onto its balance sheet]. Here’s an excuse to do more of it.
5. Oh, one might wish, for the existence of a combined Treasury/Debt Management Office in Euroland, who would issue new debt into the market, spending the proceeds in the South, where aggregate demand more obviously falls short of supply.
6. Yet the benefits of 4 and 5 depend, to repeat, on how you view QE working. If QE is predominantly about signalling lower future central bank policy rates, then these correctives to QE might not undermine that signal. On the other hand, if QE is about changing the mix of public and private sector assets in the hands of private investors, then corrective policies have to be careful not to correct this aggregate! They would have to be about redistributing between private participants; or ensuring that supply was even across sovereign maturities and bond types.