E Massive Asset Purchases By Central Banks Have Distorted Interest Rates

Central bank assets have been soaring, as the Covid-19 global recession has forced the major central banks to accelerate their support for their economies. And of course, all of this has distorted central bank interest rates and the yields on government bonds. 

First let us review the somewhat unprecedented expansion in central bank assets which has become almost normalized since the Great Recession of 2008-09.

What stands out in the first two charts is that the four large central banks have dramatically escalated their total asset purchases since the pandemic recession started early in 2020.

In US dollar terms, the largest increase in assets was at the European Central Bank (ECB), and the smallest asset expansion was at China’s central bank (PBOC) . 

The Bank of Japan (BoJ) and the Fed posted massive asset increases since the beginning of the year. Nonetheless, relative to the size of the economy, the expansion of the asset base in Japan far outstripped the other three central banks. Indeed, this Japanese trend has been going on for the past six years. 

As is well known, due to aggressive central bank purchases of assets, the resulting benchmark interest rates used by the central banks all hover around zero, even though the path toward the zero varied somewhat among the different countries. 

The US Fed’s target rate for the federal funds rate is currently 0.13%, whereas the equivalent ECB deposit rate is -0.50%, and the BOJ rate is -0.06.

The pandemic recession insured these virtually zero interest rate targets, though the ECB and the BoJ were actually there even before the pandemic. The European Central Bank introduced its negative interest rate policy in 2014 and Japan followed in 2016. 

Finally, with unprecedented heavy government borrowing to offset the recession and to maintain liquidity in the financial markets, government and private borrowing rates were obviously also pushed down to extremely low levels.   

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