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Quantitative Easing and the Liquidity Channel of Monetary Policy

Lucas Herrenbrueck

Discussion Papers from Department of Economics, Simon Fraser University

Abstract: How do central bank purchases of illiquid assets affect interest rates and the real economy? In order to answer this question, I construct a parsimonious and very flexible general equilibrium model of asset liquidity. In the model, households are heterogeneous in their asset portfolios and demand for liquidity, and asset trade is subject to frictions. I find that open market purchases of illiquid assets are fundamentally different from helicopter drops: asset purchases stimulate private demand for consumption goods at the expense of demand for assets and investment goods, while helicopter drops do the reverse. A temporary program of quantitative easing can therefore cause a ‘hangover’ of elevated yields and depressed investment after it has ended. When assets are already scarce, further purchases can crowd out the private flow of funds and cause high real yields and disinflation, resembling a liquidity trap. In the long term, lowering the stock of government debt reduces the supply of liquidity but increases the capital-output ratio. The consequences for output are ambiguous in theory but a calibration to US data suggests that the liquidity effect dominates; in other words, the supply of Treasuries is ‘too small’.

Keywords: Monetary theory; asset liquidity; search frictions; quantitative easing; liquidity trap (search for similar items in EconPapers)
JEL-codes: E31 E40 E50 G12 (search for similar items in EconPapers)
Pages: 51
Date: 2014-12-06, Revised 2016-04
New Economics Papers: this item is included in nep-mac and nep-mon
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Related works:
Working Paper: Quantitative Easing and the Liquidity Channel of Monetary Policy (2016) Downloads
Working Paper: Quantitative Easing and the Liquidity Channel of Monetary Policy (2016) Downloads
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