EFTA01388571

The limits of monetary policy ECB balance sheet and 10-year Bund yields et b'h Clte4 CA>) • ' 6:ancti g.riuht aria. fvrzrtatii 6:6 1 604 sht-61.41 200, 2010 201.1 2016 Sttn.M. Blocontvg Prdrof LP. Ocasscht 44461.Y4406.416e4 kW0.191 vrti emoi: as 4! 0d2014 6 2 4 5 Fed balance sheet and 10-year Treasuries •;.0'.i S 6.06 ■ let 10poir L1.6 Troaar4* 01 ■ Fal b1WC oxwt11/6 axifl 4.006 6 0 2005 tam :t4.6 2010 2012 2014 2016 Sctrort Woonbeig Fifty" LP. Devtlthe Nazi hisnaortpx4 Pottetty406101.1, 46 <2 002014 For such a widely used tool, it is surprising how hard it is to make QE work in theory, The trouble is that any such framework must take its longer-term impact into account. Fortunately, central banks not much keener than stage magicians to let you in on the inner workings of their latest creations. Asa result, it is fairly easy to figure out what is known --and, more worryingly, what even central banks do not know. We know from empirical studies in the United States, the United Kingdom, and, in recent years, the Eurozone and Japan, that OE "works" in the short term in terms of moving markets, and perhaps, even increasing lending. We have some ideas on why this might be so. It remains unclear, however, how QE will impact inflation, economic activity and asset prices across the economic cycle. From a theoretical perspective, we know that households and firms will try to anticipate future central-bank actions which risks offsetting much of what the central bank is doing through the channels described above in the here and now. To take the example of the wealth effect, let's say that the Fed buys 30-year bonds today, drives down nominal market rates and thereby increases the nominal value of the longer maturity bonds I hold in my portfolio. On paper, this makes me wealthier. If I am rational, though, I will know that returns on any additional bond investments I make to save for my retirement will be lower. Moreover, if and when QE does its job in restoring full employment, interest rates will increase, so I will face losses in the future. My real wealth, over my remaining life-time, has not really gone up, and there is little reason why I should boost my consumption. Instead, I might even decide to save more! 4 6 6 As a useful starting point for figuring when central-bank open- market operations do and do not impact the private sector, see Wallace, N. (1981). A Modigliani- Miller theorem for open-market operations. American Economic Review, 71(3):267-74. Past performance is not indicative of future returns. No assurance can be given that any forecast, investment objectives and/or expected returns will be achieved. Allocations are subject to change without notice. Forecasts are based on assumptions, estimates, opinions and hypothetical models that may prove to be incorrect.The information herein reflect our current views only, are subject to change, and are not intended to be promissory or relied upon by the reader. There can be no certainty that events will turn out as we have opined herein. CONFIDENTIAL - PURSUANT TO FED. R. CRIM. P. 6(e) DB-SDNY-0092203 CONFIDENTIAL SDNY GM_00238387 EFTA01388571