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Quantitative Easing and Direct Lending in Response to the COVID-19 Crisis

Filippo Occhino ()

No 202029, Working Papers from Federal Reserve Bank of Cleveland

Abstract: When the COVID-19 crisis hit the economy in 2020, the Federal Reserve responded with numerous programs designed to prevent a collapse in bank credit and firms’ available funds. I develop a dynamic general equilibrium model to study how these programs work and to evaluate their effectiveness. In the model, quantitative easing works through three channels: the expansion of bank reserves lowers a liquidity premium, the purchase of assets lowers a volatility risk premium, and the economic stimulus lowers a credit risk premium. Since bank reserves are currently larger than in the past, the liquidity premium channel is weaker, and quantitative easing is less effective. Direct lending to firms at a market rate is also less effective. Direct lending to firms at a subsidized rate can be more stimulative than quantitative easing, provided that it lowers firms’ marginal borrowing rate and user cost of capital.

Keywords: Quantitative easing; credit easing; liquidity premium; risk premium; COVID-19 (search for similar items in EconPapers)
JEL-codes: E32 E43 E51 E52 E58 (search for similar items in EconPapers)
Pages: 29
Date: 2020-10-05
New Economics Papers: this item is included in nep-dge, nep-mac and nep-mon
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DOI: 10.26509/frbc-wp-202029

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