DP11381 QE in the future: the central bank's balance sheet in a fiscal crisis
|Publication Date:||July 2016|
|Keyword(s):||new-style central banks, Unconventional Monetary Policy|
|JEL(s):||E44, E58, E63|
|Programme Areas:||Monetary Economics and Fluctuations|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=11381|
Analysis of quantitative easing (QE) typically focus on the recent past studying the policy's effectiveness during a financial crisis when nominal interest rates are zero. This paper examines instead the usefulness of QE in a future fiscal crisis, modeled as a situation where the fiscal outlook is inconsistent with both stable inflation and no sovereign default. The crisis can lower welfare through two channels, the first via aggregate demand and nominal rigidities, and the second via contractions in credit and disruption in financial markets. Managing the size and composition of the central bank's balance sheet can interfere with each of these channels, stabilizing inflation and economic activity. The power of QE comes from interest-paying reserves being a special public asset, neither substitutable by currency nor by government debt.