RDP 2023-04: Can We Use High-frequency Yield Data to Better Understand the Effects of Monetary Policy and Its Communication? Yes and No! 5. Documenting Shock Measures during the COVID-19 Pandemic

The above analysis shows that while the KMS approach does not seem to add much to our quantitative understanding of the macroeconomic effects of monetary policy shocks in Australia, it is still a potentially useful framework for understanding the multi-faceted nature of monetary policy decisions and their communication.

Such a framework could be particularly useful in trying to interpret the RBA's COVID-19-era policy. The cash rate was reduced to around the effective lower bound, and various unconventional policies were introduced, including a yield curve target and a bond purchase program. Previous work has analysed these programs and their effects on markets in detail, exploiting differential outcomes across different markets and instruments (Finlay, Titkov and Xiang 2022). However, the KMS approach provides another lens through which to examine these policies, decomposing them into effects on expected rates and term premia using a statistical model.

As such, we apply the KMS approach to a number of key dates around the announcement of the RBA's package of support policies, including the yield curve target and the bond purchase program. These are based on the dates examined in Finlay et al (2022). The full list is covered in Table 3.^[15]

The analysis is similar to the work of Kaminska and Mumtaz (2022), who find that term premia play a larger role in monetary policy shocks in the UK post-quantitative easing period (from 2009 to 2019). However, our analysis differs in a number of ways. First, we focus on a shorter period and a smaller number of specific announcements, more akin to an event study approach. And relatedly, we only focus on the first step of the approach, decomposing rate changes into changes in expected rates and term premia. Given the cash rate was at the effective lower bound for most of the event dates, the further decomposition into ‘Action’, ‘Path’ and ‘Premia’ seems less relevant.

More importantly, our ATSM does not explicitly account for the effective lower bound on interest rates (or asset purchases). Previous work has shown that failing to account for the effective lower bound can lead the ATSM to expect rates to pick up more quickly than the market actually expects (e.g. Andreasen and Meldrum 2013). In turn this will bias down the premia, and therefore may cause us to overstate the role of term premia compared to rate expectations. As such, the result should be thought of as somewhat of an upper bound on the role of premia.

Figure 12 shows the results focusing on the March announcements of the first package. As discussed in Finlay et al (2022), this led to a large decline in yields at the short end of the curve but, on net, a moderate increase in longer-term yields. Our results imply that a decline in expected future interest rates pushed down yields at the short end of the curve, consistent with the market interpreting the announcements as signalling that the cash rate would be kept low for a period, particularly the announcements on 19 March which included an announcement of the yield curve target. The announcement of the yield curve target also coincided with a substantial decline in the premia on yields for 3-year bonds not evident elsewhere on the curve, suggesting that part of the effects of the policy came through this channel. This finding is consistent with Lucca and Wright's (2022) findings for Australia, and more generally with D'Amico and King's (2013) findings of ‘local supply effects’ on targeted maturity bonds for US bond purchases.

Focusing on the long end of the curve, the documented rise in rates seems to have largely reflected increases in premia. As noted by Finlay et al (2022), it is hard to make a strong case that the announcement ‘caused’ premia on longer-term yields to rise, but it does suggest that the announcement did little to lower the premia.

Focusing on the later dates associated with the bond purchase program, we see that much of the effects seem to have come through lower premia, with only a smaller share of the decline reflecting lower expected future rates (Figure 13). This finding is similar to that of Finlay et al (2022) and suggests that the program largely worked through reducing premia. It is broadly consistent with other findings in the literature, though findings on the split between premia and signalling do vary across different unconventional monetary policy programs (e.g. Busetto et al 2022).

More generally, during the COVID-19 period term premia appear to have played a much larger role in the transmission of monetary policy and monetary policy announcements. To see this, Table 4 compares the share of variation in rates accounted for by rate expectations for pre- and during COVID-19 monetary policy announcement dates. This is similar to the findings in Kaminska and Mumtaz (2022) for the United Kingdom. Taken together, the results suggest a much larger role for term premia in the transmission of COVID-19-era policy, consistent with Finlay et al (2022).

Footnote

Finlay et al (2022) mainly focus on open-to-close changes. For simplicity we focus on previous close-to-close changes. [15]