Central Banks' Quasi-Fiscal Policies and Inflation

Although central banks recently expanded their balance sheets by unconventional policy actions, little theory is available to explain how and when central banks’ balance sheets affect inflation and impose restrictions on monetary policy. A DSGE model predicts that central banks’ balance sheet shocks affect inflation through private agents’ portfolio adjustments when fiscal authorities do not financially support central banks. In those cases, central banks cannot successfully unwind inflated balance sheets and stabilize inflation during the implementation of exit strategy. Therefore, fiscal authorities’ backup is a pre-condition for effective monetary policy when central banks are engaged in quasi-fiscal policy roles.