Working Paper: CEPR ID: DP10594
Authors: Pierpaolo Benigno; Salvatore Nistic
Abstract: We analyze the effects on inflation and output of unconventional open-market operations due to the possible income losses on the central bank's balance sheet. We first state a general Neutrality Property, and characterize the theoretical conditions supporting it. We then discuss three non-neutrality results. First, when treasury's support is absent, sizeable balance-sheet losses can undermine central bank's solvency and should be resolved through a substantial increase in inflation. Second, a financially independent central bank - i.e. averse to income losses - commits to a more inflationary stance and delayed exit strategy from a liquidity trap. Third, if the treasury is unable or unwilling to tax households to cover central bank's losses, the wealth transfer to the private sector also leads to higher inflation. Finally, we argue that non-neutral open-market operations can be used to escape suboptimal policies during a liquidity trap.
Keywords: Central banks; Balance sheet; QE; Unconventional monetary policy
JEL Codes: E40
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Absence of Treasury Support (G33) | Central Bank Financial Health (E58) |
| Central Bank Financial Health (E58) | Inflation (E31) |
| Absence of Treasury Support (G33) | Inflation (E31) |
| Central Bank Aversion to Income Losses (E58) | Inflationary Monetary Policy (E52) |
| Central Bank Aversion to Income Losses (E58) | Delayed Exit from Liquidity Trap (E19) |
| Treasury Inability to Tax (H26) | Wealth Transfer Effects (H23) |
| Wealth Transfer Effects (H23) | Inflation (E31) |
| Treasury Inability to Tax (H26) | Inflation (E31) |