Central Bank Market Neutrality is a Myth

The idea that the monetary policy portfolios of central banks can be market neutral is comprehensively dismantled in this powerful article from Pierre Monnin and Chiara Colesanti Senni of the Council on Economic Policies.

They argue that while market neutrality is a core concept guiding monetary policy implementation at the European Central Bank (ECB) and other central banks, it is not only conceptually ambiguous but is in fact a myth. In reality, asset purchases are often far from neutral, and central banks make many choices favouring some assets over others. As a result, they shape relative prices and funding conditions for companies.

Monnin and Senni begin by pointing out that central bank interventions are already conceptually at odds with the notion of market neutrality since intervention itself is not neutral and “the whole point of intervention is to intervene”. They outline the many ways in which central banks make non-neutral decisions in their monetary policy operations, showing how the choice of transmission channel has different effects for different enterprises and how sovereign bonds purchases are far from reflective of the market, especially at the ECB.

Central banks largely restrict corporate bond purchases to listed assets, thus favouring larger companies over the small and medium ones. Other market-influencing choices made by central banks concern asset classes, investment vehicles, economic sectors, credit risk, minimum issuance, maturity and the choice of the index used to allocate holdings. All of these decisions affect central bank exposures to some individual equities over others and thus favour some companies and activities over others.

The effects of these interventions are illustrated by recent research showing that fossil fuel and other high-emission sectors and companies are dramatically over-represented in the ECB’s Corporate Sector Purchase Programme portfolio compared to their actual market and economic positions.

Central banks make many non-neutral choices in their monetary policy and filter the application of that policy in many ways, and so the universe from which central banks buy assets is not reflective of the market. The authors acknowledge that the reasons for central banks making these choices are often absolutely valid. Their core point is that, in reality, market neutrality does not exist.