Asset Purchases in a Monetary Union with Default and Liquidity Risks

Huixin Bi, Andrew Foerster and Nora Traum

No RWP 24-13, Research Working Paper from Federal Reserve Bank of Kansas City

Abstract: Using a two-country monetary-union framework with financial frictions, we study sovereign default and liquidity risks and quantify the efficacy of asset purchases. Default risk increases with government indebtedness and shifts in the fiscal limit perceived by investors. Liquidity risks increase when the default probability affects credit market tightness. The framework indicates that shifts in fiscal limits, more than rising government debt, played a crucial role for Italy around 2012. While both default and liquidity risks can dampen economic and financial conditions, the model suggests that the magnifying effect from liquidity risks can be more consequential. In this context, asset purchases can stabilize economic conditions especially under scenarios of elevated financial stress.t purchases can effectively stabilize economic conditions, especially in scenarios of elevated financial stress.

Keywords: Monetary and fiscal policy interaction; unconventional monetary policy; Regime-Switching Models (search for similar items in EconPapers)
JEL-codes: E58 E63 F45 (search for similar items in EconPapers)
Pages: 40
Date: 2024-12-03
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mon, nep-opm and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://www.kansascityfed.org/documents/10598/rwp24-13bifoerstertraum.pdf Full text (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:fip:fedkrw:99294

Ordering information: This working paper can be ordered from

DOI: 10.18651/RWP2024-13

Access Statistics for this paper

More papers in Research Working Paper from Federal Reserve Bank of Kansas City Contact information at EDIRC.
Bibliographic data for series maintained by Zach Kastens ().