Working Paper: CEPR ID: DP9995
Authors: Aloisio Araujo; Susan Schommer; Michael Woodford
Abstract: We consider the effects of central-bank purchases of a risky asset, financed by issuing riskless nominal liabilities (reserves), as an additional dimension of policy alongside ?conventional? monetary policy (central-bank control of the riskless nominal interest rate), in a general-equilibrium model of asset pricing and risk sharing with endogenous collateral constraints of the kind proposed by Geanakoplos (1997). When sufficient collateral exists for collateral constraints not to bind for any agents, we show that central-bank asset purchases have no effects on either real or nominal variables, despite the differing risk characteristics of the assets purchased and the ones issued to finance these purchases. At the same time, the existence of collateral constraints allows our model to capture the common view that large enough central-bank purchases would eventually have to effect asset prices. But even when central-bank purchases raise the price of the asset, owing to binding collateral constraints, the effects need not be the ones commonly assumed. We show that under some circumstances, central-bank purchases relax financial constraints, increase aggregate demand, and may even achieve a Pareto improvement; but in other cases, they may tighten financial constraints, reduce aggregate demand, and lower welfare. The latter case is almost certainly the one that arises if central-bank purchases are sufficiently large.
Keywords: No keywords provided
JEL Codes: D53; E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Central bank asset purchases (when collateral constraints do not bind) (E58) | No impact on real or nominal variables (E19) |
| Central bank asset purchases (when collateral constraints bind) (E51) | Relax financial constraints (G59) |
| Relax financial constraints (G59) | Increase aggregate demand (E00) |
| Relax financial constraints (G59) | Potential Pareto improvements (D61) |
| Central bank asset purchases (when collateral constraints bind) (E51) | Tighten financial constraints (E62) |
| Tighten financial constraints (E62) | Reduce aggregate demand (E19) |
| Tighten financial constraints (E62) | Lower welfare (I39) |
| Central bank asset purchases (acquiring a significant portion of the collateral good) (E52) | Tighten constraints for some households (H31) |