Impact of Quantitative Easing Announcements on UK Asset Values

Quantitative easing (often abbreviated as QE) is a type of monetary policy in which a bank buys long-term securities from a given open market so that it can increase the supply of money and encourage investing and lending. The central bank purchases financial assets like government bonds in order to introduce money into the economy. Economists argue that QE helps keep the unemployment rate lower, wages higher, and economic growth stronger.

Time Series

The data consists of daily/monthly data on asset value and yields sourced from the Bank of England for the period of 4 January 2010 to 21 January 2020. The descriptive statistics of the data presented in table 1 show that the average corporate bonds index over the period is 294.04 with a spread of 51.66. The lowest is 204.58 and the highest is 390.88. THE average FTSE100 is 6538.25 with a deviation from the mean value of 708.71 while the average FTSE250 is 15653.61 with the spread around themean value of 15653.61. The average sterling overnight index average is 0.47 and the deviation from the mean value of 0.13. The lowest value is 0.16 and the largest value is 0.74. The average five-year inflation zero couponsare 2.74 with a deviation of 0.34 from the meanwhile the average nominal zero-coupon five-year yield is 1.21 with a deviation around the mean value of 1.21. The average real zero five year yield coupon is -1.54 with a deviation around the mean value of 0.76. the average 3-month gilt repo interest rate is 0.47 while the average 3-month treasury bill rate is 0.37

stats cbonds FTSE100 FTSE250 sonia infZc5y nomzc5y realzc5y grir3m tbills3m
mean 294.04 6538.25 15751.70 0.47 2.74 1.21 -1.54 0.47 0.37
sd 51.66 708.71 3556.18 0.13 0.34 0.63 0.76 0.09 0.13
p50 297.93 6625.25 16288.80 0.46 2.83 1.06 -1.42 0.49 0.40
min 204.58 4805.80 9139.65 0.16 1.97 0.14 -3.23 0.26 0.02
max 390.88 7877.45 22108.29 0.74 3.47 2.94 0.22 0.63 0.57
N 2501 2501 2501 2501 2501 2501 2501 2106 1854


The next table presents the summary statistics by the dummy variable created to capture the period and the immediate period after quantitative easing news. The result shows that while corporate bonds index, FTSE100, FTSE200, five-year inflation zero-coupon fell after the news, average nominal zero-coupon five-year yield, average real zero five year yield coupon, average 3-month gilt repo interest rate, average 3-month treasury bill rate rises after the news. However, we see that these changes are minute and this is evident from figure 1.

stats cbonds FTSE100 FTSE250 Sonia infzc5y nomzc5y realzc5y grir3m tbills3m
mean 299.46 6604.05 16099.02 0.47 2.76 1.15 -1.62 0.47 0.36
sd 51.11 706.79 3526.95 0.14 0.34 0.60 0.74 0.09 0.13
p50 301.22 6714.91 16800.71 0.46 2.86 1.03 -1.48 0.48 0.39
min 204.58 4805.80 9139.65 0.16 1.97 0.17 -3.23 0.26 0.02
max 390.88 7877.45 22108.29 0.74 3.47 2.94 0.22 0.63 0.57
N 1724 1724 1724 1724 1724 1724 1724 1410 1213
After Quantitative Easing News
mean 282.01 6392.26 14981.09 0.47 2.70 1.34 -1.36 0.49 0.38
sd 50.86 691.36 3501.40 0.11 0.33 0.67 0.76 0.08 0.12
p50 274.99 6431.85 15497.99 0.46 2.77 1.17 -1.31 0.50 0.42
min 205.02 5007.16 9433.59 0.21 1.98 0.14 -3.17 0.26 0.02
max 384.56 7787.97 22058.99 0.71 3.46 2.93 0.14 0.62 0.57
N 777 777 777 777 777 777 777 696 641

The time series plot divided between pre and post QE shows no noticeable difference between these variables from pre to post QE.


Figure 1: time series plot of variables by QE news

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METH0DOLOGY

The Vector Autoregression Model (VAR) was used to examine the effect of QE announcement on financial assets yield, exchange rates, and interest rates. VAR isa natural extension of the univariate autoregressive model to dynamic multivariatetime series. It often provides superior forecast than the univariate models and is based on plausible, theory-based simultaneous equation models. Forecasts from VAR are quite flexible and through the impulse response graph, we can examine the effect of shock of one variable on the other.

Since the VAR model should be based on stationary series, the first step is to examine the stationarity of variables making up the model and non-stationary variables be differenced to make them stationary. After this, the optimal lag length is determined using various information criteria like the AIC, SIC, FPE, and others. After determining the optimal lag length we estimate the VAR model below

Where Π_iare (n×n)coefficient matrices and ε_tis an (n×1)unobservable zero-mean white noise vector process with time-invariant covariance matrix Σ. Y_tis the vector of the endogenous variable. Specifically, 

Where: ERI is the effective sterling exchange rate index; CBONDS is the corporate bond index; SONIA is sterling overnight index average; INFZC5Y is 5-year inflation zero-coupon; NOMZC5Y is the 5 years nominal zero-coupon and INFZC5Y is the 5 years real zero-coupon; GRIR3M is the 3-month gilt repo interest rate. TBILLS3M is the average 3-month treasury bill rate; GDP is the Gross Domestic Product; CPI is the consumer price index and QEA is a dummy variable measuring QE announcement. The variable is defined as

After the estimation of the VAR model, we determine the response of all endogenous variables to shocks in the QE announcement. i.e. This involves reparameterization of the VAR model in VMA form by writing the above VAR model using the lag operator.

A(L)is the lag polynomial

This can be rewritten as 

Differentiating Yi,t, with respect to ε_(j,t)gives the response of variable I to shock in variable j.

Results

The first step is to check for the stationarity of the variables. The result shows that while FTSE100, FTSE250, and five-year inflation zero-coupon are stationary at levels; Average sterling overnight index average, average corporate bonds index, average nominal zero-coupon five-year yield, real zero five year yield coupon, average 3-month gilt repo interest rate, and the average 3-month treasury bill rate are all stationary at first difference.



  levels firs difference
eri 0.3421 <0.001
cbonds 0.3666 <0.001
FTSE100 0.0003  
FTSE250 0.0003  
sonia 0.9302 <0.001
infzc5y 0.0299  
nomzc5y 0.1436 <0.001
realzc5y 0.1229 <0.001
grir3m 0.9727 <0.001
tbills3m 0.9965 <0.001
Next, we determine the optimal lag order for the VAR model. The result shows that all the decision criteria selected lag 1 as the optimal lag order.

Therefore, the VAR model was estimated with one lag, and to estimate the effect of QE announcement on the variables, we plot the impulse response function as discussed below

Quantitative Easing and Sterling Overnight Index Average

The response of the Sterling Overnight Index Average to QE announcement is displayed by the impulse response graph shown below. We observe that immediately after the announcement there is a rise in Sterling Overnight Index Average for the next day before coming down on the third day, after the third day, the shock died down which is evidence of the stability of the VAR model.

Quantitative Easing and UK Treasury Bill Yield

The response of UK Treasury Bill Yield to the QE announcement is displayed by the impulse response graph shown below. it can be seen from the graph that there is a jump in the yield of treasury bills immediately after the announcement but the shock dies off over time and before the seventh day.

Quantitative Easing and UK-medium Term Bond Yields

The response of the 3-month gilt repo to the QE announcement is shown by the plot below. The response is similar to the UK treasury bill yield in that the immediate response to shock is to jump and then gradually fall and by the end of the fifth period which means it took five days to adjust to the shock of the announcement.

Macroeconomics

With the result above, we see that the QE announcement significantly affects financial assets, stock price, and the exchange rate, which means that it works through all channels of monetary policy transmission. QE announcement affects real interest rate, which in turn affects investment spending and leads to changes in overall aggregate demand. The change in aggregate demand means there will be a change in economic activities. Moreover, the effect on the stock price causes moral hazard and adverse selection, which change the structure of lending activities and investment. QE announcement also affects the nominal interest rate, which in turn affects cash flow and causes changes in lending activity investment. Moreover, we see that the QE announcement affects the price level. Thus, through these unanticipated price level changes, QE affects economic activity. Moreover, CPI is for necessary goods and the fall in it that accompanies the QE announcement means the low-income group is better off. Moreover, we see that the QE announcement affects the exchange rate, which leads to changes in net export and thus economic activities. The foregoing evidence shows that QE is effective in stimulating economic activities and is evident in the IRF graph of the response of GDP to the QE announcement as shown below. From the plot, we see that GDP rise even though infinitesimal throughout the period covered on the plot. This shows QE announcement has a long-lasting effect on economic activities. Thus, QE is effective in stimulating economic activities and reducing income inequality.

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