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Quantitative easing and financial stability

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  • Michael Woodford

Abstract

The massive expansion of central-bank balance sheets in response to recent crises raises important questions about the effects of such “quantitative easing” policies, both on financial conditions and on aggregate demand (the intended effects of the policies), and their possible collateral effects on financial stability. The present paper compares three alternative dimensions of central-bank policy —conventional interest-rate policy, increases in the central bank’s supply of safe (monetary) liabilities, and macroprudential policy (possibly implemented through discretionary changes in reserve requirements). In the context of a simple intertemporal general-equilibrium model, the paper shows why they are logically independent dimensions of variation in policy, and how they jointly determine financial conditions, aggregate demand, and the severity of the risks associated with a funding crisis in the banking sector. The results suggest that quantitative easing policies may be useful as an approach to aggregate demand management not only when the zero lower bound precludes further use of conventional interest-rate policy, but also when it is not desirable to further reduce interest rates because of financial stability concerns.

Suggested Citation

  • Michael Woodford, 2016. "Quantitative easing and financial stability," Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 19(2), pages 04-77, August.
  • Handle: RePEc:chb:bcchec:v:19:y:2016:i:2:p:04-77
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    References listed on IDEAS

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    Cited by:

    1. Reis, Ricardo, 2016. "Funding quantitative easing to target inflation," LSE Research Online Documents on Economics 67883, London School of Economics and Political Science, LSE Library.
    2. Cúrdia, Vasco & Woodford, Michael, 2016. "Credit Frictions and Optimal Monetary Policy," Journal of Monetary Economics, Elsevier, pages 30-65.
    3. repec:eee:dyncon:v:82:y:2017:i:c:p:195-205 is not listed on IDEAS
    4. Lucrezia Reichlin, 2017. "Non-Standard Monetary Policy and Financial Stability," ifo DICE Report, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 15(1), pages 25-27, 04.
    5. repec:ces:ifodic:v:15:y:2017:i:1:p:19307492 is not listed on IDEAS
    6. Klingelhöfer, Jan & Sun, Rongrong, 2017. "Macroprudential Policy, Central Banks and Financial Stability: Evidence from China," MPRA Paper 79033, University Library of Munich, Germany.
    7. Li, Yang, 2017. "Interest rates and financial fragility," Journal of Economic Dynamics and Control, Elsevier, pages 195-205.
    8. Andreas Schabert, 2017. "Welfare-Enhancing Distributional Effects of Central Bank Asset Purchases," Working Paper Series in Economics 94, University of Cologne, Department of Economics.

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