An Expansionary Effect of QE Not via the Signaling Channel

In recent years, central banks have engaged in massive purchases of long-term government bonds once their policy rate is stuck at zero. The standard view is that such a policy influences economic activities by sending the public a signal about the future path of nominal interest rates. I demonstrate that, with an appropriate institutional arrangement between the central bank and the fiscal authority in place, such a policy has an expansionary effect without the signaling channel. The arrangement consists of the two following ingredients. First, the fiscal authority commits to covering possible losses on the central bank's balance sheet. Second, the fiscal authority commits to a certain sequence of primary surpluses. In this setup, the consolidated government's budget must incur losses at a time of liftoff from the zero lower bound. This results in an increase in inflation via the mechanism highlighted by the fiscal theory of the price level.