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Jagjit S. Chadha

13 September 2021
WORKING PAPER SERIES - No. 2588
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Abstract
In response to the coronavirus (Covid-19) pandemic, there has been a complementary approach to monetary and fiscal policy in the United States with the Federal Reserve System purchasing extraordinary quantities of securities and the government running a deficit of some 17% of projected GDP. The Federal Reserve pushed the discount rate close to zero and stabilised financial markets with emergency liquidity provided through a new open-ended long-term asset purchase programme. To capture the interventions, we develop a model in which the central bank uses reserves to buy much of the huge issuance of government bonds and this offsets the impact of shutdowns and lockdowns in the real economy. We show that these actions reduced lending costs and amplified the impact of supportive fiscal policies. We then run a counterfactual analysis which suggests that if the Federal Reserve had not intervened to such a degree, the economy may have experienced a significantly deeper contraction as a result from the Covid-19 pandemic.
JEL Code
E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation
E40 : Macroeconomics and Monetary Economics→Money and Interest Rates→General
E51 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Money Supply, Credit, Money Multipliers
31 August 2020
WORKING PAPER SERIES - No. 2463
Details
Abstract
The Federal Reserve responded to the global financial crisis by initiating an unprecedented expansion of central bank money (bank reserves) once the policy rate had reached the lower bound. To capture the salient features of the crisis, we develop a model where the central bank can provide reserves on demand and also use reserves to buy government bonds. We show that the provision of reserves through either channel reduces the cost of providing loans as they act as a substitute for private sector collateral and costly monitoring activity. We illustrate this mechanism by examining the role of reserves in projecting stable growth in broad money after the financial crisis. We also run a counterfactual which suggests that, if the Federal Reserve had not provided bank reserves on such a large scale, broad money would have fallen, the economy might have experienced a deeper contraction, and the recovery would have been more protracted, taking perhaps twice as long to return to equilibrium.
JEL Code
E31 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Price Level, Inflation, Deflation
E40 : Macroeconomics and Monetary Economics→Money and Interest Rates→General
E51 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Money Supply, Credit, Money Multipliers