Is There a Portfolio Rebalancing Channel of QE in Latvia?

Working paper 5/2023

Illustrative photo cover
Photo by: Latvijas Banka

Portfolio rebalancing is a key mechanism through which central bank asset purchases flatten the yield curve, thus providing additional monetary policy accommodation when conventional policy rate setting is constrained by the effective lower bound. Existing literature provides ample evidence that this channel has played a major role in compressing the long-term interest rates and provided a broad-based easing of financial conditions for firms and households in the euro area. However, this evidence originates from either aggregate euro area or its largest jurisdic- tions, leaving the effects of the Eurosystem’s asset purchases on smaller member states, such as Latvia, unclear. Therefore, we employ a bilateral structural vector autoregression, featuring both aggregate euro area and Latvian blocks, as well as a panel structural vector autoregression with cross-sectional heterogeneity to obtain evidence from both macro-level and bank-level data in order to shed some light on the transmission of QE to the Latvian economy. Our findings suggest that QE led to a compression of sovereign borrowing costs in Latvia and boosted economic ac- tivity and prices. At the same time, we also document that the further pass-through to domestic financial conditions was weak owing to limited asset rebalancing by the domestic banking sector in response to the Eurosystem’s QE. Instead, we show that Latvian yields were compressed due to direct intervention of the central bank in the bond markets and portfolio readjustment of foreign investors. Our study thus provides additional evidence that the transmission of common monetary policy to the Latvian economy is impaired via the domestic banking sector.

Keywords: quantitative easing, portfolio rebalancing, monetary policy, euro area, Latvia

JEL Codes: C54, E50, E52, E58

APA: Zlobins, A. (2023, 01. dec.). Is There a Portfolio Rebalancing Channel of QE in Latvia?. Taken from https://www.macroeconomics.lv/node/6130
MLA: Zlobins, Andrejs. "Is There a Portfolio Rebalancing Channel of QE in Latvia?" www.macroeconomics.lv. Tīmeklis. 01.12.2023. <https://www.macroeconomics.lv/node/6130>.

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