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Replumbing Our Financial System: Uneven Progress

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  • Darrell Duffie

    (Graduate School of Business, Stanford University)

Abstract

We introduce large-scale asset purchases (LSAPs) as a monetary policy tool within a macroeconomic model.We allow for purchases of both long-term government bonds and securities with some private risks. We argue that LSAPs should be thought of as central bank intermediation that can affect the economy to the extent there exist limits to arbitrage in private intermediation. We then build a model with limits to arbitrage in banking that vary countercyclically and where the frictions are greater for private securities than for government bonds. We use the framework to study the impact of LSAPs that have the broad features of the different quantitative easing (QE) programs the Federal Reserve pursued over the course of the crisis. We find that (i) LSAPs work in the model in a way mostly consistent with the evidence; (ii) purchases of securities with some private risk have stronger effects than purchases of government bonds; (iii) the effects of the LSAPs depend heavily on whether the zero lower bound is binding. Our model does not rely on the central bank having a more efficient intermediation technology than the private sector: We assume the opposite.

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Bibliographic Info

Article provided by International Journal of Central Banking in its journal International Journal of Central Banking.

Volume (Year): 9 (2013)
Issue (Month): 1 (January)
Pages: 251-280

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Handle: RePEc:ijc:ijcjou:y:2013:q:0:a:12

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  1. Adam Copeland & Antoine Martin & Michael Walker, 2010. "The tri-party repo market before the 2010 reforms," Staff Reports 477, Federal Reserve Bank of New York.
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Cited by:
  1. Jorge Cruz Lopez & Jeffrey Harris & Christophe Hurlin & Christophe PĂ©rignon, 2014. "CoMargin," Working Papers halshs-00979440, HAL.
  2. Allen, Franklin & Vayanos, Dimitri & Vives, Xavier, 2014. "Introduction to financial economics," Journal of Economic Theory, Elsevier, vol. 149(C), pages 1-14.
  3. Michael R. King & Carol Osler & Dagfinn Rime, 2013. "The market microstructure approach to foreign exchange - Looking back and looking forward," Working Paper 2013/12, Norges Bank.

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