Safe Asset Scarcity and Monetary Policy Transmission

Abstract

Most central banks exited their decade-long accommodative monetary policy cycle by first raising rates, rather than starting by reducing their balance sheet. We show that the scarcity of government bonds—which were purchased under QE and held by central banks—reduces the transmission of rate hikes to money market rates. In July 2022, when the ECB increased its policy rates by 50bp for the first time in a decade, rates of repo transactions collateralized by the scarcest bonds increased by only 30bp. We show that this imperfect pass-through to repo rates is priced in treasury yields. Heterogeneous bond holdings across institutions imply that collateralized funding costs vary significantly across European institutions.