By Matteo Falagiarda
This paper develops a simple Dynamic Stochastic General Equilibrium (DSGE) model capable of evaluating the effect of large purchases of treasuries by central banks. The model exhibits imperfect asset substitutability between government bonds of different maturities and a feedback from the term structure to the macroeconomy. Both are generated through the introduction of portfolio adjustment frictions. As a result, the model is able to isolate the portfolio rebalancing channel of Quantitative Easing (QE). This theoretical framework is employed to evaluate the impact on yields and the macroeconomy of large purchases of medium- and long-term treasuries recently carried out in the US and UK. The results from the calibrated model suggest that large asset purchases of government assets had stimulating effects in terms of lower long-term yields, and higher output and inflation. The size of the effects is nevertheless sensitive to the speed of the exit strategy chosen by monetary authorities.
While it is relatively easy to talk informally about the effects of the quantitative easing program, doing it formally in a model that takes into account the general equilibrium effects on prices, and especially the yield curve, is quite difficult. Matteo Falagiarda finds an interesting ways to do it and manages to come up with some quantitative answers that highlights that the exit strategy is crucial. We will see how that will turn out to be.