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Unconventional Monetary Policy, Leverage & Default Dynamics

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  • Edoardo Palombo

    (Queen Mary University of London)

Abstract

The objective of this paper is to investigate the effectiveness of credit easing policy in mitigating the economic fallout from a financial recession using a model that can account for the observed default and leverage dynamics during the financial crisis of 2007. A general equilibrium model is developed with a financial sector and endogenous asset defaults able to account for the observed default and leverage dynamics. Following an adverse aggregate shock, banks deleverage through two channels: (i) higher non-performing loans provisions, and (ii) lower the marginal return of assets. Credit policy is modelled as an expansion of the central bank’s balance sheet countering the disruption in private financial intermediation. Unconventional monetary policy, namely credit easing policy, is shown to be ineffective in mitigating the effects of a financial crisis due to its crowding out effect on the private asset market. Other non-monetary policy tools such as credit subsidies and their efficacy considered.

Suggested Citation

  • Edoardo Palombo, 2020. "Unconventional Monetary Policy, Leverage & Default Dynamics," Working Papers 910, Queen Mary University of London, School of Economics and Finance.
    • Handle: RePEc:qmw:qmwecw:910
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    File URL: https://www.qmul.ac.uk/sef/media/econ/research/workingpapers/2020/wp910_compressed.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    unconventional monetary policy; credit easing; credit subsidies; financial frictions; default; leverage; financial sector.;
    All these keywords.

    JEL classification:

    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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