Japan’s foreign exchange interventions in 2003-2004 not only depressed U.S. and Japanese bond yields but also the yields of other countries whose bond markets were part of the integrated global bond market, according to a working paper from the Bank for International Settlements (BIS).
The authors argue that intervention in currency markets is similar to the large-scale asset purchases (LSAPs) that have become popular with central banks as an unconventional tool of monetary policy when interest rates are at the zero bound.
While currency intervention in the 1930s involved gold, today’s intervention by central banks typically involves the purchase of bonds. But in addition to affecting the value of a currency through intervention, the purchase of bonds results in easier monetary conditions, either though the effect on market liquidity or through a portfolio balance effects.
One of the more recent examples of such as global portfolio balance effect was a drop in international bond yields in response to the U.S. Federal Reserve’s asset purchases in 2008-2009, the authors note, referring to a 2010 study.
Building on earlier work by current Federal Reserve Chairman Ben Bernanke, who in 2004 established that U.S. government bond yields declined during the period of Japanese foreign exchange intervention, the authors find that the same intervention also caused a decline in long-term interest rates around the world.
“We find that simultaneously, government bond yields and interest rate swap rates decreased in a range of industrial countries, including Japan, as well as in emerging market economies whose bond markets are well integrated into global bond markets. This points to a global portfolio balance effect that reflects the global integration of many bond markets,” the paper said.
The paper thus offers an insight into today’s debate over easy monetary policy in advanced economies and its effect on other countries, either their currencies or their asset prices – an issue known as the currency wars.
In addition, the findings also illustrate how the policies and intervention of a central bank in one country affects other countries, a point that the general manger of the BIS, Jaime Caruana, has argued should be systematically taken into account by policymakers.
While the U.S. may have welcomed lower bond yields as a side-effect of Japan’s intervention in 2003, China’s investment in U.S. bonds in 2005-2006 would have been less welcome as it may have contributed to the so-called conundrum of interest rates, the paper said.
“In general, when cycles are not in synchronicity, as in early 2011 when emerging market economies were tightening monetary policy as leading economies sought to ease monetary conditions, large bond purchases, whether as unconventional monetary policy or as an incidental consequence of currency intervention, would be welcome in some places and problematic in others,” the paper said.
Click to read the paper: “Currency Intervention and the global portfolio balance effect: Japanese lessons” by Petra Gerlach-Kristen, Robert McCauley and Kazuo Ueda.