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Inflation, financial conditions and non-standard monetary policy in a monetary union. A model-based evaluation

Listed author(s):
  • Lorenzo Burlon

    ()

    (Bank of Italy)

  • Andrea Gerali

    ()

    (Bank of Italy)

  • Alessandro Notarpietro

    ()

    (Bank of Italy)

  • Massimiliano Pisani

    ()

    (Bank of Italy)

This paper evaluates the macroeconomic effects of purchases of long-term sovereign bonds by a central bank in a monetary union when (1) the private sector faces tight financial conditions and (2) the zero lower bound (ZLB) on the policy rate holds. To this end, we calibrate a dynamic general equilibrium model to the euro area (EA). We assume that households in one member country have a large initial debt position and are subject to a borrowing constraint. We simulate the effects of a negative EA-wide demand shock that induces a decline in inflation. The main results are as follows. First, the reduction in inflation amplifies the domestic and cross-country spillovers of the negative demand shock because of the country-specific borrowing constraint and the ZLB. Second, sovereign bond purchases boost economic activity and, hence, indirectly allow households to reduce their debt and relax the borrowing constraint. Third, the new, lower value of debt allows households to smooth consumption, fostering macroeconomic resilience not only in the member country concerned but also in the rest of the monetary union.

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File URL: http://www.bancaditalia.it/pubblicazioni/temi-discussione/2015/2015-1015/en_tema_1015.pdf
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Paper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 1015.

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Date of creation: Jun 2015
Handle: RePEc:bdi:wptemi:td_1015_15
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  17. D’Amico, Stefania & King, Thomas B., 2013. "Flow and stock effects of large-scale treasury purchases: Evidence on the importance of local supply," Journal of Financial Economics, Elsevier, vol. 108(2), pages 425-448.
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  22. Andrea Gerali & Alessandro Notarpietro & Massimiliano Pisani, 2015. "Structural reforms and zero lower bound in a monetary union," Temi di discussione (Economic working papers) 1002, Bank of Italy, Economic Research and International Relations Area.
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