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Systemic risk under non-conventional monetary policy

Systemic risk under non-conventional monetary policy

Central bank operations in the form of quantitative easing, qualitative easing, forward guidance and collateral policies wield great influence over market prices of risk. These policies reduce market volatility by design, compromising statistical assessment of risk and fostering leverage through endogenous market dynamics, such as collateral amplification. Also, current non-conventional monetary policies become less effective with increasing use. Yields, credit spreads, and term premia all have effective lower bounds and the more they are compressed, the less incremental economic support can be provided. Yet reversing such policies is challenging since leveraged institutions become dependent on cheap funding and credit market stabilization programs. In future economic downturns, another policy regime break is likely, possibly towards monetary financing of fiscal expansion. Hence, macro trading strategies need to consider the structural change in the monetary policy response function.[…]