The Transmission of Unconventional Monetary Policy in UK Government Debt Markets

Abstract

Through its quantitative easing programme the Bank of England has looked to manage the supply of nominal UK government securities in order to lower interest rates. In doing so it has removed more than 25 per cent of the overall supply of those securities from the publicly accessible market. The benchmark New Keynesian model suggests this should only have an impact on interest rates insofar as it affects expectations of future policy rates, whilst alternative theoretical frameworks imply a direct effect of changes in supply onto yields. Our aim is to test for the existence of these potential transmission mechanisms. We find empirical evidence to support the existence of both channels. Our analysis suggests the Bank's quantitative easing programme reduced yields by around 25 basis points through the supply channel alone. Importantly, we find that such supply effects have remained significant in recent years, suggesting that as quantitative easing is unwound the increase in publicly available supply will put upward pressure on interest rates. Lastly we highlight the monetary-fiscal interaction inherent in our result and discuss some of the issues it raises for policymakers.