Quantitative Easing, Collateral Constraints, and Financial Spillovers

The steady application of Quantitative Easing (QE) has been followed by big and non-monotonic effects on international asset prices and international capital flows. These are difficult to explain in conventional models, but arise naturally in a model with collateral. This paper develops a general-equilibrium framework to explore QE’s international transmission involving an advanced economy (AE) and an emerging market economy (EM) whose assets have less collateral capacity. Capital flows arise as a result of international sharing of scarce collateral. The crucial insight is that private AE agents adjust their portfolios in different ways in response to QE, conditional on whether they are (i) fully leveraged, (ii) partially leveraged or (iii) unleveraged. These portfolio shifts of international assets can diminish or even reverse the effectiveness of ever-larger QE interventions on asset prices. The model provides a simultaneous interpretation of several important stylized facts associated with QE.