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A Monetary Analysis of Balance Sheet Policies

Markus Hörmann and Andreas Schabert
University of Cologne, Working Paper Series in Economics No. 68, 2013

JEL codes: E32, E52, E58

Keywords: Unconventional monetary policy, collateralized lending, quantitative easing, liquidity premium, zero lower bound

We augment a standard macroeconomic model to analyze the effects and limitations of balance sheet policies. We show that the central bank can stimulate real activity by changing the size or the composition of its balance sheet, when interest rate policy is ineffective. Specifically, the central bank can stabilize the economy by increasing money supply against eligible assets even when the policy rate is at the zero lower bound. By changing the composition of its balance sheet, it can affect interest rates and, for example, neutralize increases in firms’ borrowing costs, which is not possible under a single instrument regime. We further analyze the limitations of balance sheet policies and show that they are particularly useful under liquidity demand shocks.

A Monetary Analysis of Balance Sheet Policies