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The global financial crisis that followed
the collapse of Lehman Brothers in September 2008 led a number of central banks
to accelerate their target policy rates reduction effectively to its zero-lower
bound (ZLB), but signs of economic recovery remain exceedingly fragile. When primary
instrument of monetary policy reduces as low as possible, central banks
confronted with a range of unusual challenges beyond the scope of standard
accounts of the monetary policy theory.


primary issue should be considered as the interbank crisis due to the
disruption of secured lending transactions in which the borrower of funds provides
securities as collateral. Indeed, money markets are seriously disrupted, as
indicated by the significant increase in spreads between LIBOR, which is a
reference rate for unsecured interbank borrowing and lending, and the fixed
rate overnight-indexed swap (OIS), which is a common risk free-rate proxy, of
comparable maturities. These changes were strongly correlated with the change
in credit spread and repo rate for securitized bonds, implying higher
uncertainty about solvency and lower values for collateral. Due to lack of
market confidence throughout financial crisis, Wolski and van de Leur (2016)
observe that the unsecured market segment is characterized by higher interest
rate and lower lending volume than the secured market. However, in term of
secured market, Martin, Skeie, and Thadden (2014)
show that financial institutions may not be able to roll over its short-term
borrowing, despite it being collateralized, because of two conditions, one
related to the institution’s liquidity, and one to its collateral. In fact, during
the escalating stage of financial crisis, there is a downgrade of derivatives’
value, following downward revisions of underlying assets price, raising
suspicions regarding uncertainty not only asset price but also the financial capital
of financial intermediaries. Brunnermeier and Pedersen (2009) present that price
volatility raises the financier’s expectation about future volatility, and this
leads to increased margins secured borrowing (haircut). Moreover, if the
deterioration in the value of financial institutions’ assets that can be pledge
as collateral leads to a large, discontinuous drop in its market price, money
markets are fragile and there is common illiquidity across secured and
unsecured funding (Ranaldo, Rupprecht, and Wrampelmeyer,

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Importantly, Heider and Hoerova (2009) argue that secured lending served as a
key channel of the monetary policy transmission mechanism. Therefore, to
alleviate severe fragility of money market, the central bank has intervened to
correct this market fragmentation, and recovering asset’s value is at the
central of policy makers’ efforts to reform the whole financial system.


addition to asset price shock, modern economy has confronted with the ZLB phenomenon.

Eggertsson and Woodford (2003) argue that the current threshold level at or
close to zero can be a significant constraint on the ability of a central bank
to combat liquidity trap. When conventional monetary policies were proved insufficient
during overnight lending rates are close to the ZLB, problems with financial
intermediation mean that the traditional monetary transmission mechanism was
not working. Under these circumstances, the central bank announced that they
may be forced to begin purchases of longer-term securities, known as
quantitative easing (QE), as part of its new unconventional monetary policy
strategy mainly aimed at pushing down longer-term government bond yields,
injecting liquidity into financial markets, and enlarging the pool of the eligible
collateral accepted for lending operations. Noting that longer-term government
bond yields were referred to as benchmarks for pricing various assets, hence
the lowering government bond yields prompt not only the long-term private
borrowing rates to decline themselves but also a range of assets’ value to recover
(Klyuev, De Imus, and Srinivasan 2009)


So far, the recent literature has concentrated
primarily on two channels of QE transmission mechanism that alleviate the
liquidity crisis and then overall banking systems through its impact on
long-term interest rates. One is a signaling channel, which works through
changing market expectations about future monetary policy (Bauer and Rudebusch, 2013). Indeed, the
announcement of QE program can be seen as a signaling device that the crisis
would be longer and more severe and monetary stimulus will not be withdrawn
until durable recovery is in sight, hence an explicit commitment to keeping
short-term interest rate low has a stronger impact on an expectation of market
than its actual implementation (Belke,
Gros, and Osowski 2016). The other effect is a portfolio
balance channel, which arises from the reduction in the available supply of the
assets purchased (Christensen and Krogstrup 2016 and Vayanos and Vila 2009). The
QE programs increase the bargaining power of sellers – private sector – towards
buyers – central bank – in the markets for the long-term assets, and thus bid
up the prices of targeted assets or, equivalently, put downward pressure on
these long-term yields, and thus risk premium.


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