Central Bank Lending and Inflation
Central banks have responded to the current financial crisis with an unprecendented program of lending to banks and other financial institutions. In some cases, this lending has lead to a substantial increase in the monetary base. Can such lending programs cause an increase in inflation? Is so, under what circumstances? I investigate these questions in a dynamic general equilibrium model with overlapping generations of agents. The model illustrates how unsterilized central bank loans of currency can improve welfare during a liquidity crisis. It also shows, however, how such lending can introduce less-desirable equilibria with higher inflation rates. Other forms of lending, including sterilized loans using central bank bonds, can capture the same benefits without introducing the higher-inflation equilibria.
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