Working Paper: CEPR ID: DP11287
Authors: Michael Woodford
Abstract: 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.
Keywords: macroprudential policy; money premium; zero lower bound
JEL Codes: E44; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Quantitative Easing (QE) (E51) | Financial Stability Risks (F65) |
| Conventional Interest Rate Policy (E43) | Financial Stability Risks (F65) |
| Quantitative Easing (QE) (E51) | Aggregate Demand (E00) |
| Macroprudential Policy + Quantitative Easing (QE) (C54) | Aggregate Demand (E00) |
| Quantitative Easing (QE) (E51) | Risk-Taking Behavior by Banks (G21) |
| Conventional Interest Rate Policy (E43) | Risk-Taking Behavior by Banks (G21) |