Abstract
We study how Asset Purchase (AP) policies affect the real price of defaultable nominal bonds, accounting for the effect on inflation through the central bank balance sheet. In the context of noisy financial markets where investors have position limits and private information on default probabilities, APs twist the distribution of equilibrium prices from which investors learn and effectively reduce real returns. In the absence of fiscal backing from the treasury, APs however create inflation through their effect on the real value of the central bank balance sheet. We study the social efficiency of AP policies in a stylized heterogeneous agents model, where lower bond returns and higher inflation have offsetting effects on aggregate consumption and welfare. We find that a positive but finite amount of APs optimally balances this trade-off, when we restrict to simple, uncontingent AP policies. We then show that policies that target a specific asset price can reduce interest rates while minimizing inflation pressures, even when the central bank lacks fiscal backing or has the same information as the market.
Local Organizer: Jérémy Boccanfuso