Latest / Monetary Policy Explained with Fexingo: Central Banks, Money Supply, and Interest Rates / How Central Banks Use Credit Easing to Target Specific Markets
Transcript
- Lucas: So there's this term that gets thrown around a lot — 'quantitative easing' — and people usually think they know what it means. Central bank prints money, buys government bonds, pushes down long-term rates. Fine. But there's a cousin of QE that's actually more interesting in some ways, and it's called credit easing. Luna: Credit easing. Right. That's when the central bank doesn't just buy Treasuries, but specifically goes after private sector assets — corporate bonds, asset-backed securities, things like that. Lucas: Exactly. And the key difference is intent. QE is about the quantity of reserves — the central bank wants to increase the money supply broadly. Credit easing is about the composition of the central bank's balance sheet. It's trying to fix a specific broken market, not just pump liquidity into the system. Luna: So it's more surgical. Less a fire hose, more a scalpel. Lucas: That's the idea. And we've seen it used in really interesting ways over the past decade and a half. The Fed did it during the 2008 crisis when they bought agency mortgage-backed securities — that was credit easing, because they were targeting the housing market specifically, not just buying Treasuries. Luna: But the most dramatic example in the U.S. was probably the Secondary Market Corporate Credit Facility in 2020 — the SMCCF. Lucas: Exactly. That was the first time the Fed ever bought corporate bonds directly. And not just investment-grade — they eventually included high-yield ETFs. That was a huge step. The Fed basically said, 'The corporate bond market is seizing up, and we're going to step in as a buyer of last resort.' Luna: And it worked. Credit spreads tightened almost immediately after the announcement, even before they bought a single bond. Lucas: Right. And that's the power of the signaling channel. But the actual purchases mattered too. By August 2020, the Fed held about $13 billion in corporate bonds through the SMCCF. Small relative to the $3 trillion in Treasuries they bought during the same period, but it sent a clear message: we're willing to backstop this market. Luna: But wasn't that controversial? I mean, the Fed is picking winners and losers when it buys corporate bonds — or at least picking sectors. Lucas: Hugely controversial. Critics said the Fed was bailing out companies that should have failed. But the counterargument is that in a panic, all credit freezes up — good companies and bad companies alike. If the market stops distinguishing, central bank intervention can prevent a cascade of otherwise avoidable bankruptcies. Luna: It's also a question of moral hazard. If companies know the Fed will buy their bonds in a crisis, they might take on more leverage. Lucas: That's the classic worry. And the Fed has been pretty clear that smccf type programs are only for emergencies. They even closed the facility at the end of 2020, despite the pandemic still raging, because markets had stabilized. They wanted to show it wasn't permanent. Luna: Other central banks have gone further, though. The Bank of Japan has been buying ETFs and corporate bonds for years, not just in emergencies. Lucas: That's a great point. The Bank of Japan's credit easing is on a completely different scale. They own about 80% of the Japanese ETF market. They buy corporate bonds, commercial paper, even REITs. And they've been doing it since 2010, long before Abenomics. For the BOJ, credit easing is a structural policy, not a crisis tool. Luna: And they also have yield curve control, which is a kind of credit easing — targeting a specific yield on 10-year government bonds. Lucas: Right. Yield curve control is another form of sector targeting, but on the sovereign side. The BOJ says 'we will buy as many 10-year bonds as needed to keep the yield at 0%.' That's a direct price target, not just a quantity target. Luna: Then there's the European Central Bank with its TLTROs — targeted longer-term refinancing operations. Those are loans to banks, but at negative rates, and the rate gets even more negative if banks lend to the real economy. Lucas: That's a fascinating example because it's credit easing through the banking system. The ECB isn't buying assets directly — it's giving banks cheap funding with conditions. If you lend to businesses, you get a better rate. So it's a targeted incentive, not a direct purchase. Luna: But does credit easing actually work better than QE for achieving specific goals? Or is it just a more interventionist approach? Lucas: The evidence is mixed. A 2021 paper by the Bank for International Settlements looked at various credit easing programs and found that they did narrow credit spreads and boost lending in targeted sectors. But the effects on overall GDP and inflation were smaller. So it's good for fixing market functioning, less powerful for aggregate demand. Luna: That makes sense. If you're a plumber fixing a specific pipe, you don't expect to flood the whole house. Lucas: Right. But here's the risk: once you start targeting specific markets, you're making a sectoral policy choice. The Fed buying mortgage-backed securities in 2008 effectively subsidized housing finance. The ECB's TLTROs favor bank-dependent economies like Italy over capital-market economies like Germany. That's not neutral. Luna: And the political pressure can be intense. Remember when the Fed bought corporate bonds from companies like McDonald's and AT&T during the pandemic? People asked, 'Why are you helping these big companies that can access capital markets anyway?' Lucas: Exactly. The Fed argued they were buying broadly to keep the entire market functioning, not to help specific firms. But the optics were bad. And it raises a deeper question: Should central banks have the authority to allocate credit? That's traditionally a fiscal policy function. Luna: Which gets to the whole debate about 'fiscal dominance' — when monetary policy starts doing fiscal policy's job. Lucas: Precisely. And that's why most central banks prefer to use credit easing only in emergencies, and only with clear sunset clauses. The Fed's SMCCF was always intended to be temporary. The BOJ's more permanent approach is the exception, not the rule. Luna: One thing I find interesting is how credit easing interacts with the central bank's communication. When the Fed announces a credit facility, they're signaling not just that they're buying, but that they're worried about a specific sector. That signal can be self-fulfilling — it calms markets, but it also tells the public there's a problem. Lucas: That's a really good point. The announcement effect is huge. In March 2020, the mere announcement of the SMCCF caused investment-grade bond spreads to fall from over 400 basis points to about 250 in a matter of days. The Fed hadn't bought anything yet. It was all signaling. Luna: So in a way, the credibility of the central bank is the most important asset. If markets believe the central bank will follow through, they don't need to actually buy much. Lucas: Exactly. And that's where the line between QE and credit easing gets blurry. Both rely on signaling. But credit easing signals a specific market concern, while QE signals a general monetary policy stance. Luna: And by the way, something we often talk about on this show is how we're able to get into these details without any ads. And if you've been walking through the economy with us and something has clicked, that's exactly why we can keep this going — listener support. Lucas: Yeah, it's true. We don't run ads on these shows. It's a deliberate choice. If you want to support that approach, the link is buy me a coffee dot com slash fexingo. No pressure, but it helps. Luna: Absolutely. And we're grateful for every person who chips in. Now, back to credit easing — one more example I think is worth talking about: the Bank of England's Corporate Bond Purchase Scheme during the pandemic. They bought about 20 billion pounds of corporate bonds, but they designed it to be market-neutral by buying across sectors proportional to the market index. Lucas: Right. That was an attempt to minimize credit allocation. But even a market-neutral approach affects relative prices — buying proportionally still supports the entire corporate bond market, which is a policy choice. Luna: And there's a new frontier: could central banks use credit easing for climate goals? The ECB has already started tilting its corporate bond purchases toward issuers with better climate disclosures. Lucas: That's a huge debate. The ECB's 'green' quantitative easing — they call it 'climate-conscious' corporate bond purchases. They buy bonds from companies that perform better on climate metrics. Critics say that's overstepping the mandate. Supporters say climate risk is a financial risk, so it's within the central bank's remit. Luna: So credit easing is becoming a tool for more than just financial stability — it's being used for environmental policy. Lucas: And that's exactly why it's so controversial. Once you accept that central banks can target specific sectors, the question becomes: which sectors? And who decides? That's a democratic question, not just a technical one. Luna: So where does that leave us? Is credit easing here to stay, or will it be phased out as emergency programs end? Lucas: I think it's here to stay, but in a more constrained form. The Fed has made it clear that facilities like the SMCCF are for emergencies only. But the BOJ's experience shows that once you start, it's hard to exit. And the ECB is already embedding credit easing into its regular toolkit. So we're likely to see more sectoral targeting, not less. Luna: Which means central banks are becoming more like fiscal agents, whether they admit it or not. Lucas: That's the trillion-dollar question. And it's one that won't be resolved anytime soon. But understanding the difference between QE and credit easing is a good first step to following the debate. Luna: Agreed. And as always, we'll keep watching how these tools evolve.