Welfare-Enhancing Distributional Effects of Central Bank Asset Purchases

This paper shows that central bank interventions in secondary markets for private debt can enhance social welfare. We apply a model with idiosyncratic risk and limited contract enforcement, while abstracting from unusually large disruptions in financial market. By purchasing debt at above-market prices the central bank induces an increase in credit supply, by which rather borrowers than debt holders gain. We show that asset purchases can not only replicate a tax/subsidy that addresses pecuniary externalities induced by a collateral constraint, but can even improve upon the constrained efficient allocation. We further demonstrate that countercyclical asset purchases are desirable under aggregate risk, which reduce the build-up of debt in favorable times.