Impact of Quantitative Easing Announcements on UK Asset Values
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.
|After Quantitative Easing News|
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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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.
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.
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.
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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