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The Theory of Unconventional Monetary Policy

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  • Farmer, Roger E A
  • Zabczyk, Pawel

Abstract

This paper is about the effectiveness of qualitative easing, a form of unconventional monetary policy that changes the risk composition of the central bank balance sheet with the goal of stabilizing economic activity. We construct a general equilibrium model where agents have rational expectations and there is a complete set of financial securities, but where some agents are unable to participate in financial markets. We show that a change in the risk composition of the central bank's balance sheet will change equilibrium asset prices and we prove that, in our model, a policy in which the central bank stabilizes non-fundamental fluctuations in the stock market is Pareto improving and self-financing.

Suggested Citation

  • Farmer, Roger E A & Zabczyk, Pawel, 2016. "The Theory of Unconventional Monetary Policy," CEPR Discussion Papers 11196, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:11196
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    1. Arvind Krishnamurthy & Annette Vissing-Jorgensen, 2011. "The Effects of Quantitative Easing on Interest Rates: Channels and Implications for Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 42(2 (Fall)), pages 215-287.
    2. Milton Friedman, 1957. "Introduction to "A Theory of the Consumption Function"," NBER Chapters, in: A Theory of the Consumption Function, pages 1-6, National Bureau of Economic Research, Inc.
    3. Roger E.A. Farmer & Carine Nourry & Alain Venditti, 2012. "The Inefficient Markets Hypothesis: Why Financial Markets Do Not Work Well in the Real World," NBER Working Papers 18647, National Bureau of Economic Research, Inc.
    4. James D. Hamilton & Jing Cynthia Wu, 2012. "The Effectiveness of Alternative Monetary Policy Tools in a Zero Lower Bound Environment," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44(s1), pages 3-46, February.
    5. Neely, Christopher J., 2015. "Unconventional monetary policy had large international effects," Journal of Banking & Finance, Elsevier, vol. 52(C), pages 101-111.
    6. Cass, David & Shell, Karl, 1983. "Do Sunspots Matter?," Journal of Political Economy, University of Chicago Press, vol. 91(2), pages 193-227, April.
    7. Joseph Gagnon & Matthew Raskin & Julie Remache & Brian Sack, 2011. "The Financial Market Effects of the Federal Reserve's Large-Scale Asset Purchases," International Journal of Central Banking, International Journal of Central Banking, vol. 7(1), pages 3-43, March.
    8. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
    9. Milton Friedman, 1957. "A Theory of the Consumption Function," NBER Books, National Bureau of Economic Research, Inc, number frie57-1, June.
    10. K. J. Arrow, 1964. "The Role of Securities in the Optimal Allocation of Risk-bearing," Review of Economic Studies, Oxford University Press, vol. 31(2), pages 91-96.
    11. Arvind Krishnamurthy & Annette Vissing-Jorgensen, 2011. "The Effects of Quantitative Easing on Interest Rates: Channels and Implications for Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 43(2 (Fall)), pages 215-287.
    12. Farmer, Roger E A, 2002. "Business Cycles With Heterogenous Agents," CEPR Discussion Papers 3154, C.E.P.R. Discussion Papers.
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    Citations

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    Cited by:

    1. Massimo Guidolin & Valentina Massagli & Manuela Pedio, 2021. "Does the cost of private debt respond to monetary policy? Heteroskedasticity-based identification in a model with regimes," The European Journal of Finance, Taylor & Francis Journals, vol. 27(18), pages 1804-1833, December.
    2. Jeffrey R. Campbell, 2014. "Quantitative Easing in Joseph's Egypt with Keynesian Producers," Working Paper Series WP-2014-15, Federal Reserve Bank of Chicago.
    3. Jens H. E. Christensen & Signe Krogstrup, 2016. "A Portfolio Model of Quantitative Easing," Working Paper Series 2016-12, Federal Reserve Bank of San Francisco.
    4. Farmer, Roger E A, 2016. "Pricing Assets in an Economy with Two Types of People," CEPR Discussion Papers 11253, C.E.P.R. Discussion Papers.
    5. Stéphane Lhuissier & Urszula Szczerbowicz, 2022. "Monetary Policy and Corporate Debt Structure," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 84(3), pages 497-515, June.
    6. Christian Pfister & Jean-Guillaume Sahuc, 2020. "Unconventional monetary policies: A stock-taking exercise," Revue d'économie politique, Dalloz, vol. 130(2), pages 137-169.
    7. Andrew Filardo & Paul Hubert & Phurichai Rungcharoenkitkul, 2019. "The reaction function channel of monetary policy and the financial cycle," Documents de Travail de l'OFCE 2019-16, Observatoire Francais des Conjonctures Economiques (OFCE).
    8. Roger E. A. Farmer, 2018. "Pricing Assets in a Perpetual Youth Model," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 30, pages 106-124, October.
    9. Sameer Khatiwada, 2017. "Quantitative Easing by the Fed and International Capital Flows," IHEID Working Papers 02-2017, Economics Section, The Graduate Institute of International Studies.
    10. Stijn Claessens & M Ayhan Kose, 2018. "Frontiers of macrofinancial linkages," BIS Papers, Bank for International Settlements, number 95, May.
    11. Stijn Claessens & M. Ayhan Kose, 2017. "Asset prices and macroeconomic outcomes: A survey," CAMA Working Papers 2017-76, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
    12. Harrison, Richard, 2017. "Optimal quantitative easing," Bank of England working papers 678, Bank of England.

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    More about this item

    Keywords

    Qualitative Easing; Sunspots; Unconventional Monetary Policy;
    All these keywords.

    JEL classification:

    • E02 - Macroeconomics and Monetary Economics - - General - - - Institutions and the Macroeconomy
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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