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A Monetary Analysis of Balance Sheet Policies

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  • Markus Hoermann
  • Andreas Schabert

Abstract

We augment a standard macroeconomic model to analyze the effects and limitations of balance sheet policies. We show that the central bank can stimulate real activity by changing the size or the composition of its balance sheet, when interest rate policy is ineffective. Specifically, the central bank can stabilize the economy by increasing money supply against eligible assets even when the policy rate is at the zero lower bound. By changing the composition of its balance sheet, it can affect interest rates and, for example, neutralize increases in firms' borrowing costs, which is not possible under a single instrument regime. We further analyze the limitations of balance sheet policies and show that they are particularly useful under liquidity demand shocks.

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Bibliographic Info

Paper provided by University of Cologne, Department of Economics in its series Working Paper Series in Economics with number 68.

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Date of creation: 29 Dec 2013
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Handle: RePEc:kls:series:0068

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Keywords: Unconventional monetary policy; collateralized lending; quantitative easing; liquidity premium; zero lower bound;

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  1. Ashcraft, Adam & Garleanu, Nicolae Bogdan & Pedersen, Lasse Heje, 2010. "Two Monetary Tools: Interest Rates and Haircuts," CEPR Discussion Papers 8000, C.E.P.R. Discussion Papers.
  2. Ravenna, Federico & Walsh, Carl E., 2006. "Optimal monetary policy with the cost channel," Journal of Monetary Economics, Elsevier, vol. 53(2), pages 199-216, March.
  3. Han Chen & Vasco Cúrdia & Andrea Ferrero, 2011. "The macroeconomic effects of large-scale asset purchase programs," Staff Reports 527, Federal Reserve Bank of New York.
  4. Gertler, Mark & Karadi, Peter, 2011. "A model of unconventional monetary policy," Journal of Monetary Economics, Elsevier, vol. 58(1), pages 17-34, January.
  5. Cúrdia, Vasco & Woodford, Michael, 2011. "The central-bank balance sheet as an instrument of monetarypolicy," Journal of Monetary Economics, Elsevier, vol. 58(1), pages 54-79, January.
  6. Gauti B. Eggertsson, 2012. "Was the New Deal Contractionary?," American Economic Review, American Economic Association, vol. 102(1), pages 524-55, February.
  7. Francis A. Longstaff & Sanjay Mithal & Eric Neis, 2005. "Corporate Yield Spreads: Default Risk or Liquidity? New Evidence from the Credit Default Swap Market," Journal of Finance, American Finance Association, vol. 60(5), pages 2213-2253, October.
  8. Adam, Klaus & Billi, Roberto M., 2005. "Discretionary monetary policy and the zero lower bound on nominal interest rates," CFS Working Paper Series 2005/16, Center for Financial Studies (CFS).
  9. Lawrence Christiano & Roberto Motto & Massimo Rostagno, 2013. "Risk Shocks," NBER Working Papers 18682, National Bureau of Economic Research, Inc.
  10. Ben S. Bernanke & Vincent R. Reinhart & Brian P. Sack, 2004. "Monetary Policy Alternatives at the Zero Bound: An Empirical Assessment," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 35(2), pages 1-100.
  11. Paul R. Krugman, 1998. "It's Baaack: Japan's Slump and the Return of the Liquidity Trap," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(2), pages 137-206.
  12. Canzoneri, Matthew B. & Cumby, Robert E. & Diba, Behzad T., 2007. "Euler equations and money market interest rates: A challenge for monetary policy models," Journal of Monetary Economics, Elsevier, vol. 54(7), pages 1863-1881, October.
  13. Gauti B. Eggertsson & Michael Woodford, 2003. "The Zero Bound on Interest Rates and Optimal Monetary Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 34(1), pages 139-235.
  14. Jens Christensen, 2008. "The corporate bond credit spread puzzle," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue mar14.
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