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The Portfolio Balance Mechanism and QE in the Euro Area
Author(s) -
Priftis Romanos,
Vogel Lukas
Publication year - 2016
Publication title -
the manchester school
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.361
H-Index - 42
eISSN - 1467-9957
pISSN - 1463-6786
DOI - 10.1111/manc.12162
Subject(s) - economics , monetary economics , quantitative easing , market liquidity , balance sheet , basis point , bond , portfolio , monetary policy , interest rate , depreciation (economics) , asset (computer security) , risk premium , maturity (psychological) , exchange rate , central bank , financial economics , finance , microeconomics , profit (economics) , psychology , developmental psychology , computer security , capital formation , financial capital , computer science
The paper analyses quantitative easing (QE) in a dynamic general‐equilibrium model which includes assets of different types and maturity. We explicitly model asset purchases by the central bank and their impact on the central bank's balance sheet. In particular, QE is captured by central bank purchases of long‐term government bonds financed by enhanced liquidity provision to the private sector. With imperfect substitutability between asset classes, QE affects the term premium, stock prices, the exchange rate and the private sector's saving decision. We use the model to simulate the European Central Bank's (ECB's) QE path as announced in early 2015. With six basis points term‐premium reduction the model generates 0.9 per cent effective euro depreciation and raises real GDP in the euro area by 0.3 per cent and prices by 0.5 per cent by 2016. Enduring periods of low interest rates strengthen the expansionary effect of QE in the short and medium term. Frontloading of asset purchases has little impact on output and inflation effects as long as the duration of the balance sheet expansion remains unchanged. Expansionary effects of QE are reduced if the central bank purchases eligible assets from foreign rather than domestic counterparties.