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Quantitative Easing and the Liquidity Channel of Monetary Policy

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  • Herrenbrueck, Lucas

Abstract

How do central bank purchases of illiquid assets affect interest rates and the real economy? In order to answer this question, I construct a parsimonious and very flexible general equilibrium model of asset liquidity. In the model, households are heterogeneous in their asset portfolios and demand for liquidity, and asset trade is subject to frictions. I find that open market purchases of illiquid assets are fundamentally different from helicopter drops: asset purchases stimulate private demand for consumption goods at the expense of demand for assets and investment goods, while helicopter drops do the reverse. A temporary program of quantitative easing can therefore cause a 'hangover' of elevated yields and depressed investment after it has ended. When assets are already scarce, further purchases can crowd out the private flow of funds and cause high real yields and disinflation, resembling a liquidity trap. In the long term, lowering the stock of government debt reduces the supply of liquidity but increases the capital-output ratio. The consequences for output are ambiguous in theory but a calibration to US data suggests that the liquidity effect dominates; in other words, the supply of Treasuries is 'too small'.

Suggested Citation

  • Herrenbrueck, Lucas, 2014. "Quantitative Easing and the Liquidity Channel of Monetary Policy," MPRA Paper 70686, University Library of Munich, Germany, revised 10 Apr 2016.
  • Handle: RePEc:pra:mprapa:70686
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    Cited by:

    1. Athanasios Geromichalos & Lucas Herrenbrueck & Sukjoon Lee, . "The Strategic Determination of the Supply of Liquid Assets," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics.
    2. Rocheteau, Guillaume & Weill, Pierre-Olivier & Wong, Russell, 2018. "A tractable model of monetary exchange with ex-post heterogeneity," Theoretical Economics, Econometric Society, vol. 13(3), September.
    3. Herrenbrueck, Lucas & Geromichalos, Athanasios, 2017. "A tractable model of indirect asset liquidity," Journal of Economic Theory, Elsevier, vol. 168(C), pages 252-260.
    4. Paola Boel & Christopher J. Waller, 2015. "On the Theoretical Efficacy of Quantitative Easing at the Zero Lower Bound," Working Papers 2015-027, Federal Reserve Bank of St. Louis.
    5. Geromichalos, Athanasios & Herrenbrueck, Lucas, 2016. "The Strategic Determination of the Supply of Liquid Assets," MPRA Paper 71454, University Library of Munich, Germany.
    6. Hoelle Matthew, 2018. "Optimal Term Structure in a Monetary Economy with Incomplete Markets," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 18(1), pages 1-26, January.
    7. Herrenbrueck, Lucas & Geromichalos, Athanasios, 2017. "A tractable model of indirect asset liquidity," Journal of Economic Theory, Elsevier, vol. 168(C), pages 252-260.
    8. Athanasios Geromichalos & Lucas Herrenbrueck, 2017. "The Liquidity-Augmented Model of Macroeconomic Aggregates," Discussion Papers dp17-16, Department of Economics, Simon Fraser University.
    9. Athanasios Geromichalos & Lucas Herrenbrueck & Sukjoon Lee, 2018. "Asset Safety versus Asset Liquidity," Working Papers 326, University of California, Davis, Department of Economics.

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    More about this item

    Keywords

    Monetary theory; asset liquidity; search frictions; quantitative easing; liquidity trap;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • G1 - Financial Economics - - General Financial Markets
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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