Scarcity Effects of Quantitative Easing on Market Liquidity: Evidence from the Japanese Government Bond Market
IMF Working Papers, May 9, 2018
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Bibliographic details
- Authors: Fei Han
- Published: May 9, 2018
- Series: IMF Working Papers
Key findings
- Quantitative easing (QE) can improve market liquidity through channels such as relaxing bank funding constraints, increasing risk appetite, and facilitating trades.
- QE can also reduce market liquidity when the central bank’s increased holdings of certain securities create a scarcity of those securities and higher search costs in the market.
- Using security-level data from the Japanese government bond (JGB) market, the paper finds evidence of scarcity (flow) effects of the Bank of Japan (BOJ)’s JGB purchases on market liquidity.
- There is evidence that scarcity effects can dominate other liquidity-enhancing effects when the share of the BOJ’s holdings exceeds certain thresholds, implying that flow effects may depend on the stock of holdings.
Evidence and empirical scope
- Data: security-level data from the Japanese government bond (JGB) market.
- Main empirical result: BOJ JGB purchases have measurable scarcity (flow) effects that impair market liquidity under certain conditions.
- Nonlinear effect: scarcity effects may dominate alternative channels (funding relief, risk appetite, trade facilitation) once BOJ holdings pass specific threshold values.
Policy implications and considerations
- Monitor both flows and stocks of central bank holdings: the liquidity impact of QE depends not only on purchase flows but also on the accumulated stock of holdings.
- Be attentive to threshold effects: policy design should account for potential nonlinear deterioration in market liquidity when central-bank holdings of particular securities become large relative to market size.
- Consider market structure and search costs: strategies to mitigate scarcity effects could involve measures to reduce search frictions and improve availability of substitute securities.
Subjects and keywords (as listed)
- Subjects: Asset and liability management, Banking, Bonds, Financial institutions, Financial markets, Liquidity, Monetary policy, Securities markets, Sovereign bonds, Unconventional monetary policies
- Keywords: BOJ's holding, bond market, Bonds, Europe, Global, government bond, Japanese government bond, JGB cash market, JGB issue, JGB market liquidity, Liquidity, market liquidity, quantitative and qualitative monetary easing, Quantitative easing, scarcity effects, Securities markets, Sovereign bonds, Unconventional monetary policies, WP