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Central banks need to reconsider whether bond purchases are the best way to stimulate growth when interest rates are low, especially after recent asset purchases left them nursing heavy losses, a senior European monetary policymaker has said.
Isabel Schnabel, who oversees bond-buying at the European Central Bank, said in a speech on Tuesday that central banks “need to carefully assess whether the benefits of asset purchases outweigh the costs”.
Schnabel said central banks’ asset purchases — also known as quantitative easing — had “played an important role in stabilising markets at times of stress”. But she added their effectiveness in stimulating demand depends on the economic conditions at the time of the purchases and “can come with costs that might be higher than those of other policy instruments”.
Her comments underline how central bankers are becoming more sceptical about the benefits of buying vast amounts of bonds and are less likely to use them in future, especially as a tool to boost demand and lift inflation.
The ECB purchased a portfolio of mostly government bonds that was worth more than €5tn — about 35 per cent of Eurozone gross domestic product — over the past decade and it has recently started to shrink it.
But the policy has been controversial. Some critics blamed it for inflating asset price bubbles and its effectiveness as a tool for boosting inflation has been questioned. Others claimed it was a way to prop up the finances of profligate southern European governments.
Since the ECB started to raise interest rates to tackle surging inflation almost two years ago, Eurozone central banks have been left nursing multibillion-euro losses on their big bond portfolios.
In March, the ECB announced losses of €1.3bn for 2023, its first for almost two decades and warned it expected more in the coming years. Germany’s Bundesbank last year burnt through its entire €19.2bn of provisions and €3.1bn of reserves to absorb its huge losses.
The downturn in the ECB’s finances forced it to scrap the dividend it pays to national central banks last year. These dividend payments — which amounted to €5.8bn between 2018 and 2022 — are usually passed on by national central banks to Eurozone governments.
“These losses need to be viewed against the profits central banks made before the rise in interest rates, but they may still be weighing on central banks’ reputation and credibility,” Schnabel said. She was speaking in Tokyo, where the Bank of Japan continues to operate one of the most aggressive bond-buying programmes.
Asset purchases by central banks also lead to shortages of government bonds that disrupt financial markets and distort how interest rates are set, Schnabel added.
The German economist said there were alternatives to bond-buying, such as central banks lending large amounts to commercial lenders at ultra-low rates, or officials adopting “a more patient approach” when inflation is below-target and rates are already close to their lowest possible levels.
Even if they are used in future, Schnabel said central banks could reduce the costs of asset purchases “by using them in a more targeted and parsimonious manner, intervening forcefully when needed but stopping them faster”.
She said the Bank of England had provided an example of how a more targeted approach “with a clear exit strategy” could work. The UK central bank bought bonds for a fixed period during the country’s pension fund crisis of 2022 and sold them shortly after it had abated.
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