Large Scale Asset Purchases as a Tool of Monetary Policy

We introduce long-term government bonds along with private credit instruments into a monetary DSGE model with financial intermediaries that face endogenously determined balance sheet constraints. We use it to compare the effects of large-scale purchases of private and government assets after a simulated crisis experiment. Financial intermediaries are the price-setting marginal buyers of both private and government assets, so a crisis that tightens their funding constraints results in a correlated movement in private and government asset yields. We introduce agency frictions that make it more difficult for financial intermediaries to obtain funding for private than for government assets. This implies lower bond premia for government assets, in line with evidence. As a result, purchase of government assets on a comparable scale has smaller effects on yields and the real economy than purchase of private assets. We also show that a binding zero-lower bound on the nominal interest rate substantially amplifies the effects of credit policies, as it limits the offsetting effects of the interest rate rule.