The Bank of England has published a staff working paper finding that growth in non-bank financial institutions (NBFIs) leaves the transmission of conventional interest rate policy to output and inflation essentially unchanged, but can alter the effectiveness of quantitative easing (QE). The results depend on why the nonbank sector expands, rather than its size alone. The research uses a dynamic stochastic general equilibrium model estimated on UK data, linking banks, NBFIs and the central bank through wholesale deposits, bonds and reserves. When NBFIs expand because firms prefer funding through bond markets, QE has stronger effects on output and inflation. When expansion instead reflects higher costs of obtaining bank finance, QE transmission remains largely unchanged. NBFIs’ portfolio choices are central to the mechanism. Central bank purchases of government bonds encourage NBFIs to acquire corporate bonds and increase wholesale deposits with banks, transmitting the stimulus through investment and bank lending. Additional simulations indicate that QE has stronger effects when the wholesale deposit market connecting NBFIs and banks is impaired. The model also shows diminishing marginal returns to QE, although it remains effective even with a substantially larger central bank balance sheet.
Bank of England research links quantitative easing effectiveness to the drivers of nonbank financial sector growth
A Bank of England staff working paper finds that a larger non-bank financial sector has little effect on conventional interest rate transmission, while its implications for quantitative easing depend on the source of growth. In a model estimated on UK data, quantitative easing becomes more powerful when firms shift their funding preferences toward bonds, but its transmission changes little when nonbank expansion reflects higher bank financing costs.