What is an Unlimited Bond Purchase
BREAKING DOWN Unlimited Bond Purchase
An unlimited bond purchase allows a central bank to prop up bond markets in crisis by committing to purchase as many bonds as necessary to stabilize the situation. European Central Bank President Mario Draghi undertook such a program in October 2012 in an attempt to preserve the value of the euro amid the economic struggles of several eurozone countries.
The problem stemmed from sovereign debt crises in several countries following the global financial crisis of 2008. Greece, Spain, Ireland, Portugal and Cyprus all required third-party bailouts to pay off their sovereign debt. Jittery bond markets drove high yields on many government bonds, making it difficult for the central bank to execute monetary policy. While the central bank pledged it would not cap the size of the bailout, it did impose restrictions on the duration of debt it would buy and forced countries to formally request a bailout.
In effect, the purchase program diversified the risk of the distressed sovereign bonds throughout the eurozone. The action succeeded in bringing down interest rates on bonds issued by Spain and Italy, as markets perceived less risk with the central bank’s backstop in place.
Conventional and Unconventional Monetary Policy
Open market operations conducted by central banks offer some of the most potent options for affecting monetary policy. The U.S. Federal Reserve constantly buys and sells government securities on the secondary market, increasing or decreasing supplies to control liquidity in the markets. For example, the Fed can buy government bonds on the open market to inject more cash into financial systems. On the other hand, the Fed can take cash out of the system by selling its bond holdings.
Typically, monetary policy moves give the economy a nudge in one direction or another by raising and lowering available liquidity. As central banks have scrambled to respond to larger-scale crises, they have turned toward less-conventional methods. For example, the Fed implemented quantitative easing in the aftermath of the 2008 financial crisis to purchase trillions of dollars’ worth of debt securities to stabilize markets and bring yields back down. The move has broad similarities to the European Central Bank’s unlimited bond purchase program in that it bought up troubled debt to curb high yields and provide a sense of safety to debt markets. Such moves also fit with the Fed’s core mandate to act as a lender of last resort in order to prevent financial calamities.