Quantitative Tightening with Slow-Moving Capital

Zhengyang Jiang and Jialu Sun

No 32757, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We document shifts in investor composition during quantitative tightening, which suggest that investors adjust their portfolios at different speeds. To understand its implications for bond valuation, we develop a general equilibrium model which highlights the dynamic interaction between heterogeneous investors. In the model, long-term investors have higher risk-taking capacity, but face a portfolio adjustment cost; liquidity traders have lower risk-taking capacity, but can trade freely. Our model predicts a novel overshooting pattern: when the central bank unwinds its bond purchase, slow adjustment by long-term investors requires liquidity traders to absorb the imbalance, who demand a higher risk premium that creates excessive bond price decline and volatility in the short run. As a result, quantitative tightening is not simply a symmetric reversal of quantitative easing.

JEL-codes: E5 G12 (search for similar items in EconPapers)
Date: 2024-07
New Economics Papers: this item is included in nep-cba, nep-dge and nep-mon
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