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Quantitative Easing in a Small Open Economy: An International Portfolio Balancing Approach

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  • Serdar Kabaca

Abstract

This paper studies the effects of quantitative easing (QE) in a small open economy dynamic stochastic general-equilibrium model with international portfolio balancing. Portfolios are classified as imperfectly substitutable short-term and long-term subportfolios, each including domestic and foreign bonds. Unlike in standard small open economy models, both domestic and foreign bonds may be traded internationally. The model links the domestic term premium to the global term premium, and the implication of the model on the effectiveness of QE policies in reducing the domestic term premium depends crucially on the degree of substitutability between domestic and foreign bonds. The estimated model implies that QE in small open economies is expected to be much less effective on long-term yields because of the high substitutability between home and foreign assets found in the data. In the model, this causes the effect on the exchange rate to be limited. The paper also shows that foreign investors’ access to the domestic debt market is essential when evaluating the QE policy; ignoring foreign investors’ access would mistakenly make the policy look more effective.

Suggested Citation

  • Serdar Kabaca, 2016. "Quantitative Easing in a Small Open Economy: An International Portfolio Balancing Approach," Staff Working Papers 16-55, Bank of Canada.
  • Handle: RePEc:bca:bocawp:16-55
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    References listed on IDEAS

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    Cited by:

    1. Yang Zhang & Lena Suchanek & Jonathan Swarbrick & Joel Wagner & Tudor Schlanger, 2021. "Sequencing Extended Monetary Policies at the Effective Lower Bound," Discussion Papers 2021-10, Bank of Canada.
    2. Gelfer, Sacha, 2021. "Evaluating the forecasting power of an open-economy DSGE model when estimated in a data-Rich environment," Journal of Economic Dynamics and Control, Elsevier, vol. 129(C).
    3. Georgiadis, Georgios & Jančoková, Martina, 2020. "Financial globalisation, monetary policy spillovers and macro-modelling: Tales from 1001 shocks," Journal of Economic Dynamics and Control, Elsevier, vol. 121(C).
    4. Sami Alpanda & Uluc Aysun & Serdar Kabaca, 2022. "International Portfolio Rebalancing and Fiscal Policy Spillovers," Working Papers 2022-01, University of Central Florida, Department of Economics.
    5. Grahame Johnson & Sharon Kozicki & Romanos Priftis & Lena Suchanek & Jonathan Witmer & Jing Yang, 2020. "Implementation and Effectiveness of Extended Monetary Policy Tools: Lessons from the Literature," Discussion Papers 2020-16, Bank of Canada.
    6. Benjamín García & Mario González & Sebastián Guarda & Manuel Paillacar, 2022. "Unconventional credit policies during crises: A structural analysis of the Chilean experience during the COVID-19 pandemic," Working Papers Central Bank of Chile 954, Central Bank of Chile.
    7. Serdar Kabaca & Renske Maas & Kostas Mavromatis & Romanos Priftis, 2020. "Optimal quantitative easing in a monetary union," Working Papers 697, DNB.
    8. Lakdawala, Aeimit & Moreland, Timothy & Schaffer, Matthew, 2021. "The international spillover effects of US monetary policy uncertainty," Journal of International Economics, Elsevier, vol. 133(C).
    9. Martijn Boermans & Robert Vermeulen, 2018. "Quantitative easing and preferred habitat investors in the euro area bond market," DNB Working Papers 586, Netherlands Central Bank, Research Department.

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    More about this item

    Keywords

    International topics; Transmission of monetary policy;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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