Essays on the ECB Monetary Policy's Impact on Non-Financial Firms

Abstract

In recent years, one of the main problems the European Economic and Monetary Union (EMU) has been facing is slow economic growth stemming, in part, from subdued investments despite interest rates falling below the zero-lower bound (ZLB). Summers (2013) brought back the term “secular stagnation” – first coined by Hansen (1939) – to describe the United States’ economic environment following the 2008-2009 Great Recession, in which a central bank is unable to reduce interest rates enough to stimulate investment and consumption. In recent years, another term, “liquidity trap”, has also gained popularity to characterize an economy where short-term interest rates are at the ZLB, and in effect, rendering conventional monetary policy incapable of stimulating growth. Indeed, this topic has fostered extensive research on ways unconventional monetary policies could stimulate an economy (see, for example, Dominguez et al. (1998), Bernanke et al. (2004), and Eggertsson and Krugman (2012)). The European Central Bank (ECB) has been trying to ameliorate financial conditions and restore confidence in the EMU, especially after the 2011-2012 Euro Debt crisis. On July 26th, 2012 the then President of the ECB, Mario Draghi, stated the most important three words ever uttered by a central banker that he was going to do “whatever it takes” to save the Euro. Since then, the ECB has introduced an array of conventional and unconventional monetary policies to maintain the EMU project. Some of these policies include slashing interest rates below the ZLB, implementing the longer-term refinancing operations (LTRO), and targeted longer-term refinancing operations (TLTRO), and introducing quantitative easing (QE).

However, were these policies successful in encouraging investment and easing financial conditions? In this thesis, we try to answer this question from the perspective of non-financial firms. The analysis of the ECB’s unconventional policies – mainly of QE – has been widely researched, especially their effect on borrowing costs in general and government bond yields in particular (see Albu et al. (2014), De Santis (2020), Jäger and Grigoriadis (2017), and Krishnamurthy et al. (2017), among others). However, the research on corporations has been somewhat limited, although non-financial corporations (NFCs) are a vital sector, particularly for investments.

In this thesis, we focus on the ECB’s interest rate policy and its QE programmes, especially the public sector purchase programme (PSPP), and the corporate sector purchase programme (CSPP). The PSPP, first introduced on January 22nd, 2015, aimed to lower long-term sovereign bond yields by purchasing sovereign debt at an average pace of 47 billion euros a month from March 2015 to December 2018 . In total, the ECB purchased over 2.2 trillion euros worth of government bonds of EMU countries. This asset purchase programme accounted for 47% of ECB’s balance sheet.

Another vital purchase programme was the CSPP. Under this program, the ECB purchased NFC debt at a monthly pace of 5.8 billion euros from June 2016 to December 2018 for a total of 178-billion-euro worth of European corporate bonds. This programme’s goal was to lower NFCs’ borrowing costs and to induce corporate borrowing and investment spending.

This thesis consists of three independent chapters, albeit with an overarching theme of investigating the impact of ECB’s policies on NFCs.

In Chapter 2, titled Has ECB’s monetary policy prompted NFCs to invest, or pay dividends?, we take a broad view of the influence of the ECB’s conventional and unconventional policies on NFCs’ decisions on debt holdings, investments, and dividends. Toward this end, we use a unique dataset comprised of income statements and balance sheets of leading NFCs’ operating in the EMU from the four largest economies, Germany, France, Italy, and Spain.

Chapter 2 contributes to the literature by shedding light on the ECB monetary policies’ long-term effect on NFCs’ leverage and capital allocation – subjects that, to the best of our knowledge, have yet to be methodically investigated over such an extended period and encompasses the ECB’s unconventional policies.

The main results in Chapter 2 suggest that the ECB’s monetary policies have encouraged firms to raise their debt burden, especially after the global recession of 2008. The ECB’s policies, particularly after 2011, also seem to have led NFCs to allocate more resources not only to capital spending but also to shareholder distribution.

Chapter 3, titled Examining the effect of ECB monetary policy on non-financial corporations’ credit risk premia examines the usefulness of the ECB’s policies in ameliorating financial conditions and reducing the risk premia of NFCs. We collected daily credit default swaps (CDSs) prices of publicly-traded European NFCs to analyze the short-term effects of the policy announcements between June 2nd, 2014, and December 30th, 2016. We also test the long-term impact of the ECB’s policies on NFCs’ CDS prices using monthly data from January 2008 to February 2018.

Chapter 3 contributes to the literature by being the first to methodically investigate the mechanism of the ECB’s monetary policy’s short-term and long-term impact on NFCs’ CDS prices. By doing so, we assess the ECB’s various policies’ transmission mechanism to NFCs’ risk premia – a critical factor in NFCs’ borrowing costs.

The main findings in Chapter 3 are that the ECB’s asset purchase programme announcements seem to have an immediate impact on CDS daily prices; these announcements had a stronger effect, especially after the PSPP started in March 2015. From 2008 to 2012 and from 2015 to 2018, the ECB’s interest rate policy had statistically and economically significant effects in reducing CDS prices. We also find that some of ECB’s asset purchase programmes, such as the PSPP, had a statistically significant long-term impact on CDSs. These findings indicate that some of the ECB’s policies were effective in reducing NFCs’ risk premia, notably since 2015, as market conditions improved.

In Chapter 4, titled Bang for the QE buck: Examining the impact of ECB’s corporate bond purchases on firms’ credit risk, debt and investment, we focus on the CSPP. This programme, first announced in March 2016 and started by June 2016, aimed to ameliorate corporations’ financial conditions and encourage NFCs to borrow and invest.

Chapter 4 analyzes the CSPP’s short-term and long-term effect on corporate credit risk by utilizing daily (from March to August 2016) and monthly data (June 2016- December 2018) of corporate zero-volatility, and nominal spreads. We also employ NFCs’ debt covenants data to assess the pass-through of the CSPP to firms’ risk of credit. We examine the CSPP’s long-term effect on liquidity risk by using scaled bid-ask spread data. The data include purchased bonds under the CSPP (targeted bonds) and European bonds that were not purchased. We then analyze the CSPP’s short-term and long-term impact on capital structure and capital allocation of NFCs whose bonds the ECB purchased (targeted firms) compare to European firms whose bonds were not purchased. Chapter 4 contributes to the literature by shedding light on the CSPP’s short-term and long-term effect on corporate bonds’ risk premia liquidity costs. Third, to the best of our knowledge, we are also the first to investigate the CSPP’s long-term impact on firms’ borrowing costs and corporate decisions.

In Chapter 4 we find that following the CSPP announcement, targeted corporate bonds’ zero-volatility spread, and nominal spread fell by 3.5 basis points (2.6%) and 4.1 basis points (4.2%), respectively. Initially, the programme encouraged firms to borrow more and pay dividends; however, it did not improve investments. Throughout its implementation (June 2016-December 2018), the CSPP only marginally reduced targeted bonds’ risk premia and did not lower corporate bonds’ liquidity risk. Nonetheless, it reduced targeted firms’ cost of debt, improved their debt covenants, and encouraged investments.

The findings in Chapter 4 suggest the CSPP did not have a persistent impact in reducing credit risk or liquidity risk in the corporate bond market; however, it had an economically significant lasting effect in lowering corporate debt cost and stimulating investment.