Quantitative Easing and the Term Premium Channel in the Euro Area

Long-term yields can be broken down into two components: a risk-neutral rate and a term premium. While the transmission of Quantitative Easing (QE) through the risk-neutral rate is attributed to the well-known signaling effect, changes in the term premium are usually associated to the so-called portfolio-balance mechanism. However, this mapping is not entirely correct: the signaling effect can also affect the term premium. A clear distinction between the two components of long-term yields is therefore essential to quantify the transmission of QE through the yield curve. In this paper, I study the term premium channel of QE for the asset purchase programme of the European Central Bank. I find a strong dominance of the term premium channel over the risk-neutral channel, both for the transmission of QE to the yield curve and to aggregate macroeconomic variables. This term premium channel is found to have significantly raised inflation and real GDP, and was a major driving force for the macroeconomic variables from 2015 on. Using cutting-edge econometric techniques, this paper provides a robust view of the importance of the little known term premium channel of QE