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Quantitative Easing, Functional Finance, and the "Neutral" Interest Rate

  • Alfonso Palacio-Vera
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    The main purpose of this study is to explore the potential expansionary effect stemming from the monetization of debt. We develop a simple macroeconomic model with Keynesian features and four sectors: creditor households, debtor households, businesses, and the public sector. We show that such expansionary effect stems mainly from a reduction in the financial cost of servicing the public debt. The efficacy of the channel that allegedly operates through the compression of the risk/term premium on securities is found to be ambiguous. Finally, we show that a country that issues its own currency can avoid becoming stuck in a structural "liquidity trap," provided its central bank is willing to monetize the debt created by a strong enough fiscal expansion.

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    File URL: http://www.levyinstitute.org/pubs/wp_685.pdf
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    Paper provided by Levy Economics Institute in its series Economics Working Paper Archive with number wp_685.

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    Date of creation: Sep 2011
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    Handle: RePEc:lev:wrkpap:wp_685
    Contact details of provider: Web page: http://www.levyinstitute.org

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    1. Alan J. Auerbach & Maurice Obstfeld, 2003. "The Case for Open-Market Purchases in a Liquidity Trap," NBER Working Papers 9814, National Bureau of Economic Research, Inc.
    2. 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, pages 3-46, 02.
    3. Benjamin Friedman & Kenneth Kuttner, 2010. "Implementation of Monetary Policy: How Do Central Banks Set Interest Rates?," Department of Economics Working Papers 2010-03, Department of Economics, Williams College.
    4. Thomas I. Palley, 1994. "Debt, Aggregate Demand, and the Business Cycle: An Analysis in the Spirit of Kaldor and Minsky," Journal of Post Keynesian Economics, M.E. Sharpe, Inc., vol. 16(3), pages 371-390, April.
    5. Joseph Gagnon & Matthew Raskin & Julie Remache & Brian Sack, 2011. "Large-scale asset purchases by the Federal Reserve: did they work?," Economic Policy Review, Federal Reserve Bank of New York, issue May, pages 41-59.
    6. Joyce, Michael & Lasaosa, Ana & Stevens , Ibrahim & Tong, Matthew, 2010. "The financial market impact of quantitative easing," Bank of England working papers 393, Bank of England.
    7. Claudio Borio & Piti Disyatat, 2009. "Unconventional monetary policies: an appraisal," BIS Working Papers 292, Bank for International Settlements.
    8. Todd Keister & Antoine Martin & James McAndrews, 2008. "Divorcing money from monetary policy," Economic Policy Review, Federal Reserve Bank of New York, issue Sep, pages 41-56.
    9. Marc Lavoie, 2010. "Changes in Central Bank Procedures during the Subprime Crisis and Their Repercussions on Monetary Theory," Economics Working Paper Archive wp_606, Levy Economics Institute.
    10. Michele Lenza & Huw Pill & Lucrezia Reichlin, 2010. "Monetary policy in exceptional times," Economic Policy, CEPR;CES;MSH, vol. 25, pages 295-339, 04.
    11. Baumeister, Christiane & Benati, Luca, 2010. "Unconventional monetary policy and the great recession - Estimating the impact of a compression in the yield spread at the zero lower bound," Working Paper Series 1258, European Central Bank.
    12. Piti Disyatat, 2008. "Monetary policy implementation: Misconceptions and their consequences," BIS Working Papers 269, Bank for International Settlements.
    13. David Bowman & Etienne Gagnon & Mike Leahy, 2010. "Interest on excess reserves as a monetary policy instrument: the experience of foreign central banks," International Finance Discussion Papers 996, Board of Governors of the Federal Reserve System (U.S.).
    14. Scott Fullwiler & L. Randall Wray, 2010. "Quantitative Easing and Proposals for Reform of Monetary Policy Operations," Economics Working Paper Archive wp_645, Levy Economics Institute.
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