DP11287 Quantitative Easing and Financial Stability

Author(s): Michael Woodford
Publication Date: May 2016
Keyword(s): macroprudential policy, money premium, zero lower bound
JEL(s): E44, E52
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=11287

This paper compares three alternative dimensions of central-bank policy --- conventional interest-rate policy, quantitative easing, and macroprudential policy --- showing in the context of a simple intertemporal general-equilibrium model why they are logically independent dimensions of policy, and how they jointly determine financial conditions, aggregate demand, and the severity of risks to financial stability. Quantitative easing policies increase financial stability risk less than either of the other two policies, relative to the magnitude of aggregate demand stimulus; and a combination of expansion of the cental bank's balance sheet with a suitable tightening of macroprudential policy can have a net expansionary effect on aggregate demand with no increased risk to financial stability. This suggests that quantitative easing policies may be useful as an approach to aggregate demand management not only when the zero lower bound precludes further use of conventional interest-rate policy, but also when it is not desirable to further reduce interest rates because of financial stability concerns.