Financial markets : The removal of a calming hand

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  • Financial markets: The removal of a calming hand | The Economist
    http://www.economist.com/blogs/freeexchange/2013/09/financial-markets?fsrc=rss

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    The removal of a calming hand
    Sep 18th 2013, 15:08 by C.W. | LONDON
    SPECULATION is a dirty word. Market punters are often blamed for pushing securities prices from extreme to extreme, generating crises along the way. New regulations have half-heartedly tried to limit the worst excesses. 

    But some argue that another government force is buoying the speculators. To soothe worried markets, central banks have embarked on an ambitious programme of unconventional monetary policy. Measures such as quantitative easing (QE)—printing money to buy things like government bonds and mortgage securities—are in vogue. 

    Unconventional monetary policy has been attacked for prompting further financial gaming. With piles of cash to play with, the argument goes, investors have bid up prices of equities, bonds, and commodities. Stocks and shares have certainly been on the up. From a low in 2009—just after QE began—World Bank commodity price indices have increased by over 50%. The FTSE 100, an index of stock prices in Britain, has nearly reached its all-time high. 

    But a new paper from the International Monetary Fund suggests that unconventional monetary policies (UMPs) do not encourage speculation. Rather, they dampen it. UMPs reduce “tail risk”, or the odds of extreme market outcomes like hyperinflation or a new Depression. That, in turn, tamps down market volatility, and that reduces the incentive to speculate. When America announces that it will purchase more mortgage-backed securities or government bonds, markets quickly price in lower volatility. Risk measures can drop by 10% after the Federal Reserve makes unconventional monetary policy announcements, according to the IMF paper.

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