Working Paper: NBER ID: w19711
Authors: Alosio 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). The existence of collateral constraints allows our model to capture the common view that large enough central-bank purchases would eventually have to affect 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: monetary policy; collateral constraints; central bank; asset purchases
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 purchases of risky assets (E44) | Relax financial constraints (G59) |
| Relax financial constraints (G59) | Increase aggregate demand (E00) |
| Central bank purchases of risky assets (E44) | Increase aggregate demand (E00) |
| Large central bank purchases (E58) | Tighten financial constraints (E62) |
| Tighten financial constraints (E62) | Reduce aggregate demand (E19) |
| Reduce aggregate demand (E19) | Lower welfare (I39) |
| Central bank purchases (E58) | Impact on asset prices and resource allocation (G19) |
| Binding collateral constraints (G33) | Impact on asset prices and resource allocation (G19) |
| Abundant collateral (G33) | No effect on asset prices or resource allocation (G19) |