Conventional and Unconventional Monetary Policy with Endogenous Collateral Constraints

Abstract

We consider the effects of central-bank purchases of a risky asset, financed by issuing riskless nominal liabilities (reserves), as an additional dimension of policy alongside "conventional" monetary policy (central-bank control of the riskless nominal interest rate), in a general-equilibrium model of asset pricing and risk sharing with endogenous collateral constraints of the kind proposed by Geanakoplos (1997). When sufficient collateral exists for collateral constraints not to bind for any agents, we show that central-bank asset purchases have no effects on either real or nominal variables, despite the differing risk characteristics of the assets purchased and the ones issued to finance these purchases. At the same time, the existence of collateral constraints allows our model to capture the common view that large enough central-bank purchases would eventually have to effect asset prices. But even when central-bank purchases raise the price of the asset, owing to binding collateral constraints, the effects need not be the ones commonly assumed. We show that under some circumstances, central-bank purchases relax financial constraints, increase aggregate demand, and may even achieve a Pareto improvement; but in other cases, they may tighten financial constraints, reduce aggregate demand, and lower welfare. The latter case is almost certain the one that arises if central-bank purchases are sufficiently large. * We thank Kyle Jurado and Savitar Sundaresan for research assistance, and participants at presentations at IMPA, MIT, and the Cowles Foundation Conference on General Equilibrium and its Applications for helpful comments. We also acknowledge financial support from CAPES-PNPD and IMPA (Schommer), and the NSF under grant SES-0820438 (Woodford).

Monetary Policy Under the Microscope: Intra-Bank Transmission of Asset Purchase Programs of the ECB

“…Iwata and Wu (2006) provide evidence, in the United States, that the eect of expansionary monetary policy at the ZLB on output is about half compared to a non-ZLB environment. Further examples of UMP measures include forward guidance (Gertler and Karadi, 2015), targeted lending schemes, long-term lending to nancial institutions (Ferrando et al, 2015), lenient collateral frameworks (Araújo et al, 2015) and more intensive use of government securities as collateral (Acharya and Merrouche, 2013;Fratzscher and Rieth, 2015).…”

Monetary policies to counter the zero interest rate: an overview of research

“…Del Negro et al argue that collapse of liquidity for private assets was central in the Great Recession. Araujo et al (2015) emphasize constraints that stem from collateral requirements for private assets and argue that central bank policies are irrelevant when collateral is abundant but can influence markets when collateral constraints are present.…”

Incomplete Credit Markets and Monetary Policy

“…Debt contracts in this market are speci…ed and paid o¤ in nominal terms, did not attempt a negative nominal interest rate policy. 4 The literature on these two policies is already very extensive, and a complete summary is beyond the scope of this paper. To list a few, see for instance Eggertsson and Woodford (2006) and Filardo and Hofmann (2014) for forward guidance.…”

“…There is no role for collateral. For alternative theories that emphasize collateral and come to di¤erent conclusions, see Williamson (2016) and Araujo, Schommer, and Woodford (2015). 17 In Sheedy (2014), debt contracts can have long maturities.…”

“…The other is "quantitative easing"-outright purchases of both privately-issued and publicly-issued debt where the central bank changes the size of its balance sheet. 4 Both of these types of monetary policy responses have been implemented in several other large economies with policy rates constrained by the zero (or e¤ective) lower bound. In our model, when a su¢ciently large and persistent negative aggregate shock hits the economy the zero lower bound on nominal interest rates may threaten to bind.…”