#oeconomicus_english by the @econoscopejrnl

🏦 Unconventional monetary policy: when the conventional toolkit is not enough

Central banks normally use three main instruments to manage the economy: interest rates, reserve requirements and open market operations. But when interest rates approach zero and the economy still needs support, these conventional tools may lose their power. This is when unconventional monetary policy (UMP) comes into play.

The 2008 Global Financial Crisis forced central banks to adopt tools that had previously existed mainly in theory. Here is a guide to the main instruments and how they have been used.

1. Quantitative Easing (QE) — expanding the central bank balance sheet

The central bank creates new reserves and uses them to purchase government bonds and other securities from financial institutions. This increases liquidity and pushes down long-term interest rates.
📌 Example: the Federal Reserve System launched its first large-scale asset purchase program in November 2008, buying mortgage-backed securities (MBS) and agency debt. Between 2008 and 2014, the Fed's balance sheet grew from roughly $900 billion to about $4.5 trillion. The Bank of England began QE in March 2009 with an initial £75 billion, later expanded to £200 billion by November 2009.

2. Credit Easing — targeting specific frozen markets

Instead of purchasing government debt broadly, the central bank buys private-sector securities — corporate bonds, commercial paper, or asset-backed securities — to unfreeze specific credit markets and reduce risk premiums.
📌 Example: the Fed's purchases of mortgage-backed securities during the crisis are a clear case. The ECB similarly purchased covered bonds and asset-backed securities to support specific market segments.

3. Forward Guidance — shaping expectations through communication

The central bank communicates its future policy intentions to influence market expectations. If investors believe rates will remain low for an extended period, long-term borrowing costs may fall without additional asset purchases.
📌 Example: in December 2012, the Fed stated it would keep rates near zero "at least as long as the unemployment rate remains above 6.5 %" and inflation was projected to remain contained.

4. Negative Interest Rates (NIRP) — charging for excess reserves

The central bank sets its deposit rate below zero, effectively charging commercial banks for holding excess reserves. This is intended to encourage lending rather than hoarding.
📌 Example: the ECB reduced its deposit facility rate to −0.10% in June 2014, and further cut it to −0.50% by September 2019. The Bank of Japan introduced a negative rate of −0.1% on a portion of current account balances in January 2016.

5. Yield Curve Control (YCC) — targeting long-term yields

The central bank sets a specific target for government bond yields at a chosen maturity and commits to purchasing unlimited amounts to maintain that level.
📌 Example: the Bank of Japan introduced YCC in September 2016, targeting the 10-year Japanese Government Bond yield at around 0%. The Reserve Bank of Australia adopted a similar policy in March 2020, targeting the 3-year bond yield at 0.25%, but discontinued it in November 2021.

6. Funding-for-Lending Schemes — subsidizing bank credit

The central bank provides cheap long-term funding to banks on the condition that they lend to households and businesses.
📌 Example: the Bank of England and HM Treasury launched the Funding for Lending Scheme in July 2012 to improve credit conditions. Banks could borrow Treasury bills for up to four years at low cost, with additional incentives for lending to small and medium enterprises.

In conclusion, unconventional tools can provide stimulus when conventional policy is exhausted, but they carry risks: distorted market signals, compressed bank margins, and challenges to central bank independence. They are measures of last resort, not standard practice.

✍️ Written by Elmira Miftakhutdinova, 3-IER