A better way to buy private sector securities?

The novel coronavirus outbreak has caused central banks around the world to buy private sector assets on an unprecedented scale. These purchases include bonds and even equities. Yet, most central banks conducting such purchases have little idea of the real economic effects of their activities. There is also a fragile legality for asset purchase in some jurisdictions where central banks do engage in such activities.

There is a need to start rethinking the legal basis for private sector securities purchases – as well as to avoid using them in places where they have shown to hurt, rather than help, economic growth.

The effects of private asset purchases

In a recent study, Viktoria Dalko and I looked at the effect of central banks’ purchases of private sector securities. We did this by stripping out usual economic effects and aimed only to trace the economy-pumping effects of asset purchases. We also looked at the legality of these purchases. Our research resulted in four key findings.

We found that such purchases represented a powerful tool in a central bank’s box of unconventional monetary policies. For a small range of countries, like Botswana, Panama and Senegal, such purchases did stoke longer-term investment and growth. The effects of these purchases could last a decade or more, as central banks provided vital funds to a cash-starved economy.

It also emerged that some countries could grow their economies faster and better through such purchases rather than by using traditional fiscal policy. Many highly corrupt countries have relatively clean and independent central banks. Private asset purchases could have provided more funds to ‘Main Street’ than leaky and corrupt government programmes. For example, Bulgaria,Guyana, Romania and the Ukraine have central banks that might be able to act as surrogates for sometimes suspect executive government stimulus. 

For some countries, however, such purchases actually hurt growth. These purchases represented a windfall bonanza, allowing factory owners to splurge on consumption rather than productive investment. Such countries include Nicaragua, the Philippines and Russia. Why convince sceptical private investors to buy your bonds when a less discriminating central bank will take them as high-priced collateral?

The law of the jungle

Our final finding shows just how flimsy the central bank laws used to justify these purchases really are. Most central bank laws do not explicitly authorise the purchase of private assets. Despite this, central bank governors/boards have gone ahead anyway – or interpreted vague language to support such purposes, sometimes effectively behind the backs of a passive citizenry. 

Legislators should explicitly allow for these purchases of private sector stocks, bonds and other securities.

Out of six possible options we provide for legislators and rulemakers to give central banks clearer legal support for private-sector asset purchases, we favour mandate change to nominal GDP targeting. Such targeting would pull out from the shadows the implicit GDP target that most central banks use today. Who in the post-Covid world could argue that central bank policies are blind to output and GDP? Nominal GDP targets have long had support from economists.

Lawmakers and central bankers have a lot of their plates right now. But as we rethink monetary policy for the next decade(s), wouldn’t it make sense to put into law activities that central banks already practice?

Profiting as an asset manager

The research can also offer guidance to some asset managers and sell-side analysts. Knowing which countries will grow a result of these purchases versus those that will not, could help asset managers to improve their returns.

If pension and sovereign wealth funds represented the big institutional buyers of the past decade, central banks might increasingly represent the client base of asset managers in the years ahead. This means there may be an advantage in buying securities of companies and industries that have economic knock-on effects, anticipating later central bank demand, benefiting the institutions involved and society more generally.

This crisis could represent an opportunity to reform central banks’ laws – and put new rules related to asset purchases in place.

Bryane Michael is a senior fellow at the University of Hong Kong’s Faculty of Law. The views expressed in this article represent those of its author.