Chart 4  Chart 5  Real interest rates have also declined at longer horizons  Longer term yields insensitive to policy surprises  Source: Bank of England  Source: Bank of England and Bank calculations  QE is a different matter. As has been well documented elsewhere, announcements of asset purchases did have statistically significant effects on longer-term interest rates. Work at the Bank suggests that the combined effects of the various stages of QE reduced 10-year gilt yields by as much as 100bp. But it’s not clear for how long that effect has persisted: there are reasons to believe that asset purchases have a greater impact when markets are more illiquid, and have less capacity to absorb the flows. Most of the decline in longer-term real interest rates occurred before the crisis. And, in any event, the first point above still applies: judging by the subsequent behaviour of inflation, QE looks simply to have brought forward a decline in real interest rates that would have occurred anyway, only more painfully so. As the Bank of England explained in a Quarterly Bulletin article a couple of years ago, without QE we’d have experienced higher unemployment, lower wages and lower inflation. It’s hard to see bond yields rising in such an environment.
Different jurisdictions will come up with different arrangements to address this issue, but I would say that every jurisdiction is going to need its own solution. And, perhaps for the first time, that has highlighted the need for some international co-ordination of policies on shadow banks. The FSB is just starting to explore this virgin territory.21 Asset managers and incentives The vast majority of the asset management world is not engaged in shadow banking and, more important, does not of itself jeopardise the stability of the system directly if it gets into trouble. The taking and absorption of risk by unlevered funds is a fundamentally healthy part of the system. But financial stability authorities cannot be indifferent to this industry. By investing in the debt and equity of banks, it is a vital part of market discipline. We do not want – and cannot have – a system where the first line of defence after the management of banks themselves is the cadre of official sector supervisors. For the system to be healthy, we need boards, auditors, equity investors and debt holders to play a big part, and for investment decisions to be subject to constructive incentives. Yet, there is relatively little debate about whether the incentives of asset managers made the system more prone to crisis. Although not a subject for today, an important part of this is the drive to develop resolution regimes that entail debt holders taking losses on their exposures to distressed banks and dealers.