Paradigmatic change of central banking : measuring the announcement effect of ECB’s asset purchase programmes

Abstract

When the interest rates were approaching zero in the aftermath of the global financial crisis of 2008, the major central banks of the global economy adopted the use of so-called unconventional monetary policies. Of the unconventional monetary policy tools, the large-scale asset purchase programmes, also called balance sheet policies, are the most prominent one and their popularity has not declined, on the contrary. The monetary responses of the European Central Bank (ECB) and the Federal Reserve (Fed) to the latest global crisis, the Covid-19 pandemic, confirmed this as balance sheet policies were introduced once again.

The global financial crisis is seen as the turning point for monetary policy for especially the major central banks such as the ECB and the Fed. For this reason, the causes behind the crisis and subsequent ramifications are discussed in this thesis. The transition from conventional monetary policies to unconventional policies is shown and the monetary transmission mechanism, through which the monetary decisions affect the economy and asset prices, is explained.

Furthermore, this thesis measures the announcement effect of ECB’s asset purchase programmes on two major stock indices: STOXX Europe 600 and S&P 500. The announcement effect is tested with event study methodology. In order to silence the unwanted noise from other macroeconomic news that might compromise the results, a relatively short estimation period of 30 days is chosen for the event study and is placed right before the event window. Abnormal returns are then calculated over the three-day event window of [-1,1]. The results show that the announcement effect of ECB’s asset purchase programmes is significant and yields positive cumulative abnormal returns on both STOXX Europe 600 and S&P 500 indices over the three-day event window.

Finally, through discussion, this thesis argues that we are witnessing a paradigmatic change in central banking as policies once classified as unconventional have been used over the conventional ones’ ever since the financial crisis. This is especially true with the ECB as it has kept the key interest rates of the euro area close to zero for years and no change is visible on the horizon.