Inflation, Financial Conditions and Non-Standard Monetary Policy in a Monetary Union. A Model-Based Evaluation

Abstract

This paper evaluates the macroeconomic effects of purchases of long-term sovereign bonds by a central bank in a monetary union when (1) the private sector faces tight financial conditions and (2) the zero lower bound (ZLB) on the policy rate holds. To this end, we calibrate a dynamic general equilibrium model to the euro area (EA). We assume that households in one member country have a large initial debt position and are subject to a borrowing constraint. We simulate the effects of a negative EA-wide demand shock that induces a decline in inflation. The main results are as follows. First, the reduction in inflation amplifies the domestic and cross-country spillovers of the negative demand shock because of the country-specific borrowing constraint and the ZLB. Second, sovereign bond purchases boost economic activity and, hence, indirectly allow households to reduce their debt and relax the borrowing constraint. Third, the new, lower value of debt allows households to smooth consumption, fostering macroeconomic resilience not only in the member country concerned but also in the rest of the monetary union.

The Non-Standard Monetary Policy Measures of the ECB: Motivations, Effectiveness and Risks

“…percentage points cumulatively in the period between 2016 and 2020." This is indeed close to the assessment by Burlon et a. (2015) shown in Figure 12, which considers only the APP.…”

“…Real GDP growth % Source: Burlon et al (2015). Note: the charts report the contributions of the initial APP programme (announced in January 2015) and subsequent extensions and re-calibrations.…”

“…Counterfactual simulations conducted by a number of institutions, including Banca d'Italia (Burlon et al, 2015), confirm both that the APP provided a powerful stimulus to the recovery of euro area real GDP and inflation, and that the monetary expansion, while remaining essential and relevant, is gradually becoming less needed, in that economic activity and consumer price dynamics now need less support than they did until not too long ago. 23 Figure 12 reports the results of simulations carried out at Banca d'Italia, where the impact of successive "waves" of the APP is separately depicted.…”

Global Macroeconomic Effects of Exiting from Unconventional Monetary Policy

“…In this way, we relax the well known "Wallace neutrality" and make assets imperfect substitutes, since they differ for the amount of liquidity services they provide. 4 This framework allows to formalize the APP as purchases of long-term sovereign bonds by the EA monetary authority financed via narrow money injection. The model calibration, informed by the data, implies that narrow money is a more liquid asset than sovereign bonds, as the related parameter in the liquidity bundle is relatively large.…”

“…Thus, the reduction in the long-term interest rate induces those households to increase investment in physical capital. Burlon, Gerali, Notarpietro and Pisani (2015) formalize the EA as a monetary union and evaluate the impact of APP on EA member countries on the basis of a framework as in Chen, Curdia and Ferrero (2012). Different from them, we assume 1) a representative agent having an explicit demand for liquidity, that provides consumption transaction services, and 2) that liquidity is a composite of narrow money, short-and longterm sovereign bonds.…”