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A SUNSPOT-BASED THEORY OF UNCONVENTIONAL MONETARY POLICY

Published online by Cambridge University Press:  15 July 2020

Roger E. A. Farmer  and
Pawel Zabczyk
Roger E. A. Farmer*
Affiliation:
University of Warwick and University of California Los Angeles
Pawel Zabczyk
Affiliation:
International Monetary Fund
*
Address correspondence to: Roger E. A Farmer, Department of Economics, University of Warwick, Coventry, CV4 7AL, United Kingdom. e-mail: r.farmer.1@warwick.ac.uk. Phone: +44 (0) 24 761 5008.
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Abstract

This paper is about the effectiveness of qualitative easing, a form of unconventional monetary policy that changes the risk composition of the central bank balance sheet. We construct a general equilibrium model where agents have rational expectations, and there is a complete set of financial securities, but where some agents are unable to participate in financial markets. We show that a change in the risk composition of the central bank’s balance sheet affects equilibrium asset prices and economic activity. We prove that, in our model, a policy in which the central bank stabilizes non-fundamental fluctuations in the stock market is self-financing and leads to a Pareto efficient outcome.

Keywords

Qualitative EasingSunspotsUnconventional Monetary Policy
Type
Articles
Information
Macroeconomic Dynamics , Volume 26 , Issue 1 , January 2022 , pp. 186 - 217
Creative Commons
The views expressed in this article are those of the authors and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
Copyright
© International Monetary Fund 2020

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Footnotes

We thank participants of seminars at the Bank of Italy, National Institute for Economic and Social Research, Swiss National Bank, and Warwick University. Christian Hepenstrick, Francesco Lippi, and Bernard Winkler have all contributed thoughtful discussions of our work, and we thank them for their comments. We have also benefited from conversations with Ben Broadbent, Minouche Shafik, and Martin Weale.

†

An earlier incarnation of this paper with the title “Qualitative Easing: How it Works and Why it Matters” [Farmer (2012c)] appeared as an The National Bureau of Economic Research and a Centre for Economic Policy Research working paper. The current version was written after extensive discussions with Pawel Zabczyk during, and following, Farmer’s visit, as Senior Houblon-Norman Fellow at the Bank of England in 2013. Farmer thanks the Center for Central Bank Studies at the Bank of England for their hospitality.

‡

The paper’s findings, interpretations, and conclusions are entirely those of the authors and do not necessarily represent the views of the International Monetary Fund, its Executive Directors, or the countries they represent

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