Quantitative Easing and Exuberance in Government Bond Markets: Evidence from the ECB's Expanded Asset Purchase Program

Abstract

This paper examines the impact of Quantitative Easing (QE) in the Eurosystem on government bond yields and to what extent QE is causing government bond prices to deviate from their fundamental determinants. We apply a novel recursive estimation procedure developed by Phillips et al. (2015) to examine the existence of exuberant price behavior. The results show that government bond markets experienced exuberant price behavior in Euro Area countries following the announcement and implementation of several QE programs in 2014 and 2015. Especially the Public Sector Purchase Program (PSPP) contributed to exuberant price behavior as all countries experienced a divergence between observed and fundamental yield levels. However, almost no evidence of exuberance in government bond markets is found when QE policies are treated as drivers of government bond yields in addition to the traditional determinants. Given the influence of QE on government bond yields and prices, our findings imply that caution is warranted when this policy is eventually reversed.

Keywords: Government bond yields, asset price bubbles, monetary policy

JEL Classification: G12, G15, E52