Unlimited Bond Purchase Definition

What is an unlimited bond purchase?

The term unlimited purchase of bonds refers to an intervention by a central bank, which offers an open-ended commitment to buy government bonds to support debt markets. Unlimited bond purchases can be considered a particularly aggressive form of Monetary Policyoften with the aim of ensuring that credit markets continue to operate with adequate liquidity and without erratic spikes in interest rates.

Key points to remember

  • Unlimited bond purchases are one way central banks can help ensure adequate liquidity in the bond market.
  • This is a rare and aggressive move that can signal liquidity issues.
  • The European Central Bank launched an aggressive program of unlimited bond purchases in response to the 2012 European sovereign debt crisis.

How unlimited bond purchases work

An unlimited purchase of bonds allows a central bank to support bond markets in crisis by pledging to buy as many bonds as necessary to stabilize the situation. In the United States, this action can be seen as an extension of the open market operations led by the Federal Reservein which the central bank buys and sells government securities on the secondary market.

That of the Federal Reserve open market operations can be used to increase or decrease the supply of credit in the economy, to help ensure a liquidity is maintained. For example, if the Federal Reserve feels that the banks do not have enough money, it can provide that money by buying Treasury securities of these banks.

Similarly, if the Federal Reserve thinks there is too much cash in the credit markets, it can reduce the money supply by selling more Treasury bills in exchange for cash. Through these operations, the central bank aims to keep short-term interest rates within acceptable limits of its objective federal funds rate.

As central banks scrambled to respond to larger crises, they turned to less conventional methods. For example, the Fed has implemented quantitative easing the day after the 2008 financial crisis buy billions of dollars of debt securities to stabilize markets and depress yields. In this sense, the Fed acted as a so-called lender of last resort to avoid a meltdown in credit markets. Extending an unlimited bond buying program is just one extension of this strategy.

Concrete example of an unlimited purchase of bonds

European Central Bank program

A striking example of an unlimited bond buying program took place in October 2012, when European Central Bank President, Mario Draghiundertook such a program in an effort to preserve the value of the Euro amid the economic struggles of several Eurozone countries.

This decision stemmed from the sovereign debt crisis which gripped several European countries following the global financial crisis of 2008. Greece, Spain, Ireland, Portugal and Cyprus all demanded bailouts to avoid default on their sovereign bonds.

Fear of a default drove up yields on many government bonds, making it difficult for the central bank to execute monetary policy.While the central bank pledged not to cap the size of the bailout, it imposed restrictions on the length of debt it would buy and forced countries to formally request a bailout.

Indeed, the unlimited bond purchase program diversified the risk of distressed sovereign bonds throughout the eurozone.The stock succeeded in lowering interest rates on bonds issued by Spain and Italy as markets perceived less risk with central bank support in place.

Federal Reserve Response to COVID-19

The Fed took action in 2020 to support the US economy in the wake of the global COVID-19 pandemic. In March 2020, the Federal Free Market Committee (FOMC) has committed to buying Treasury securities. This was in addition to the purchase of the agency securities backed by mortgages(MBS). The central bank said it would provide “support for critical market functioning”.

The Fed also said it bought corporate bonds from about 750 companies, including Apple, ExxonMobil, Microsoft and AT&T. As of June 2020, approximately $429 million of corporate bonds had been purchased to maintain credit and allow businesses to borrow at low rates. The move was also intended to help companies avoid laying off workers during the pandemic.

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