Central Bank Lending and Inflation

Todd Keister

No 782, 2009 Meeting Papers from Society for Economic Dynamics

Abstract: Central banks have responded to the current financial crisis with an unprecendented program of lending to banks and other financial institutions. In some cases, this lending has lead to a substantial increase in the monetary base. Can such lending programs cause an increase in inflation? Is so, under what circumstances? I investigate these questions in a dynamic general equilibrium model with overlapping generations of agents. The model illustrates how unsterilized central bank loans of currency can improve welfare during a liquidity crisis. It also shows, however, how such lending can introduce less-desirable equilibria with higher inflation rates. Other forms of lending, including sterilized loans using central bank bonds, can capture the same benefits without introducing the higher-inflation equilibria.

Date: 2009
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