A Monetary Analysis of Balance Sheet Policies

We augment a standard macroeconomic model to analyze the effects and limitations of balance sheet policies. We show that the central bank can stimulate real activity by changing the size or the composition of its balance sheet, when interest rate policy is ineffective. Specifically, the central bank can stabilize the economy by increasing money supply against eligible assets even when the policy rate is at the zero lower bound. By changing the composition of its balance sheet, it can affect interest rates and, for example, neutralize increases in firms' borrowing costs, which is not possible under a single instrument regime. We further analyze the limitations of balance sheet policies and show that they are particularly useful under liquidity demand shocks.

[1]  B. Sack,et al.  Large-Scale Asset Purchases by the Federal Reserve: Did They Work? , 2010 .

[2]  Steven B. Kamin,et al.  Quantitative Easing and Bank Lending: Evidence from Japan , 2010 .

[3]  I. Stevens,et al.  The Financial Market Impact of Quantitative Easing , 2010 .

[4]  A. Krishnamurthy,et al.  The Effects of Quantitative Easing on Interest Rates , 2011 .

[5]  R. Billi,et al.  Discretionary Monetary Policy and the Zero Lower Bound on Nominal Interest Rates , 2005 .

[6]  N. Kiyotaki,et al.  Financial Intermediation and Credit Policy in Business Cycle Analysis , 2010 .

[7]  Lawrence J. Christiano,et al.  Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy , 2005 .

[8]  M. Gertler,et al.  A model of unconventional monetary policy , 2011 .

[9]  C. Walsh.  Implementing Monetary Policy , 2011 .

[10]  Ming-Deh A. Huang,et al.  Proof of proposition 2 , 1992 .

[11]  James M. Nason,et al.  The Macroeconomic Effects of Large-Scale Asset Purchase Programs ∗ , 2011 .

[12]  R. Cumby,et al.  Euler equations and money market interest rates: A challenge for monetary policy models , 2007 .

[13]  B. Bernanke.  The crisis and the policy response: a speech at the Stamp Lecture, London School of Economics, London, England, January 13, 2009 , 2009 .

[14]  Optimal Central Bank Lending , 2010 .

[15]  Paul Krugman,et al.  It's Baaack: Japan's Slump and the Return of the Liquidity Trap , 1998 .

[16]  A. Blinder.  Quantitative Easing: Entrance and Exit Strategies , 2010 .

[17]  Dimitri Vayanos,et al.  A Preferred-Habitat Model of the Term Structure of Interest Rates , 2009, Econometrica.

[18]  M. Fleming.  Federal Reserve Liquidity Provision during the Financial Crisis of 2007–2009 , 2012 .

[19]  Taehun Jung,et al.  Optimal Monetary Policy at the Zero-Interest-Rate Bound , 2005 .

[20]  Samuel Reynard,et al.  Modeling Monetary Policy , 2009 .

[21]  P. Collin‐Dufresne,et al.  The Determinants of Credit Spread Changes , 2001 .

[22]  Gauti B. Eggertsson,et al.  Zero Bound on Interest Rates and Optimal Monetary Policy , 2003 .

[23]  Janet L. Yellen.  U.S. monetary policy objectives in the short and long run , 2009 .

[24]  Shigenori Shiratsuka.  Size and composition of the central bank balance sheet: revisiting Japan's experience of the quantitative easing policy , 2010 .

[25]  B. Sack,et al.  Monetary Policy Alternatives at the Zero Bound: An Empirical Assessment , 2004 .

[26]  Nicolae Gârleanu,et al.  Two Monetary Tools: Interest Rates and Haircuts , 2010, NBER Macroeconomics Annual.

[27]  Lawrence J. Christiano,et al.  When Is the Government Spending Multiplier Large? , 2009, Journal of Political Economy.

[28]  Leonard M. Adleman,et al.  Proof of proposition 3 , 1992 .

[29]  Asani Sarkar,et al.  Financial Amplification Mechanisms and the Federal Reserve's Supply of Liquidity During the Crisis , 2010 .

[30]  Claudio E. V. Borio,et al.  Unconventional Monetary Policies: An Appraisal , 2009 .

[31]  J. H. Christensen.  The corporate bond credit spread puzzle , 2008 .

[32]  Philipp M. Hildebrand.  Monetary Policy and Financial Markets , 2006 .

[33]  Simon M. Potter,et al.  Was the New Deal Contractionary? , 2006 .

[34]  Marco Del Negro,et al.  The Great Escape? A Quantitative Evaluation of the Fed’s Non-Standard Policies , 2010 .

[35]  M. Woodford,et al.  The Central-Bank Balance Sheet as an Instrument of Monetary Policy , 2010 .

[36]  Gauti B. Eggertsson,et al.  Zero Bound on Interest Rates and Optimal Monetary Policy , 2003, Brookings Papers on Economic Activity.

[37]  Eric T. Swanson.  Let’s Twist Again: A High-Frequency Event-Study Analysis of Operation Twist and Its Implications for QE2 , 2011 .

[38]  C. Walsh,et al.  Optimal monetary policy with the cost channel , 2006 .