DP9153 Qualitative Easing: How it Works and Why it Matters

Author(s): Roger E A Farmer

Publication Date: September 2012

Keyword(s): fiscal policy , monetary policy , qualitative easing

JEL(s): E0 , E5 , E52 , E62

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP9153.asp.asp

This paper is about the effectiveness of qualitative easing; a government policy that is designed to mitigate risk through central bank purchases of privately held risky assets and their replacement by government debt, with a return that is guaranteed by the taxpayer. Policies of this kind have recently been carried out by national central banks, backed by implicit guarantees from national treasuries. I construct a general equilibrium model where agents have rational expectations and there is a complete set of financial securities, but where agents are unable to participate in financial markets that open before they are born. I show that a change in the asset composition of the central bank’s balance sheet will change equilibrium asset prices. Further, I prove that a policy in which the central bank stabilizes fluctuations in the stock market is Pareto improving and is costless to implement.