Working Paper: NBER ID: w22415
Authors: Ricardo Reis
Abstract: 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.
Keywords: Quantitative Easing; Fiscal Crisis; Central Bank Policy
JEL Codes: E44; E58; E63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| composition of the central bank's balance sheet (E58) | sensitivity of inflation to fiscal shocks (E62) |
| fiscal shock (E62) | price level (E30) |
| quantitative easing (QE) (C54) | welfare losses associated with inflation (E31) |
| quantitative easing (QE) (C54) | effective supply of safe assets (E44) |
| quantitative easing (QE) (C54) | alleviating the credit crunch (E51) |