With quantitative easing (QE), central banks buy long-term government bonds to lower long-term interest rates. QE removes from the market both the investment risk associated with ownership of the bonds and also the transaction services conveyed by these bonds, which include facilitating the matching of buyers and sellers in the bond market. To the extent that it lends its stock of bonds back to market participants, a central bank replaces these transaction services. In contrast, by not lending its bonds, the central bank further lowers long-term rates by increasing the scarcity of these transaction services. This amplification of the impact of QE on long-term rates through reduced bond lending allows the European Central Bank to achieve its QE rate objective more easily because the alternative of even greater purchases of bonds could be politically contentious.

(joint with Angela Maddaloni) For a liquid bond market, it is important that bond holders actively lend their bonds. By being able to borrow bonds without delays, dealers can better intermediate trades in this market without carrying unnecessarily large inventories. The liquidity of the bond market is essential for many other financial markets such as the futures market or derivatives market. However, we show that nonbank financial institutions such as insurance companies or pension funds do not lend their bonds as actively as banks do. Even when they do lend bonds, they earn considerably less fees than banks. Because nonbanks hold much more bonds than banks in the euro-area, their inactive lending of bonds increases the scarcity of these assets and makes it costlier for investors to borrow bonds in the market.