Non-technical summary of ESM Working Paper 77: Asset purchase programmes and the exchange rate

Asset purchase programmes (APPs) have played a central role in central banking since the global financial crisis. At the onset of the COVID-19 pandemic, not only advanced economies but also many emerging market (EM) central banks introduced APPs for the first time. While advanced economies (AEs) typically employed these programmes when policy rates were at or near zero, EMs adopted them despite having policy rates above zero. More generally, the pandemic highlighted the critical distinction between APPs used for financial stability versus those employed for monetary policy objectives.

This paper evaluates how COVID-era asset purchase programmes affected exchange rates against the US dollar in 23 EMs and seven AEs. Using daily market data to measure asset purchase surprises, the analysis shows that asset purchase programmes led to an appreciation of EM currencies, which contrasts the post-global financial crisis evidence that APPs depreciate the exchange rate in AEs. This result remains robust even after controlling for the policy actions of the Federal Reserve, including Fed swap lines, the policy actions of other AEs, and the simultaneous policy actions of the implementing country itself. 

The author explains the results through the lens of long-run uncovered interest rate parity deviations driven by sovereign credit risk. Specifically, the results highlight a “sovereign credit risk channel” in EMs, where asset purchase surprises reduce the sovereign credit risk captured by credit default swap (CDS) spreads. This channel explains why APP surprises do not necessarily decrease the underlying long-term risk-free rate and hence, lead to an appreciation of the exchange rate in EMs.

This analysis has one main policy implication showing that EMs can potentially use APPs during times of financial distress to stabilise exchange rates without necessarily intervening in the foreign exchange rate market.