DP11196 The Theory of Unconventional Monetary Policy

Author(s): Roger E A Farmer, Pawel Zabczyk
Publication Date: March 2016
Keyword(s): Qualitative Easing, Sunspots, Unconventional Monetary Policy
JEL(s): E02, E6, G11, G21
Programme Areas: Financial Economics, International Macroeconomics and Finance, Monetary Economics and Fluctuations
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=11196

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.