Quantitative Easing, Functional Finance, and the 'Neutral' Interest Rate

Abstract:     
The main purpose of this study is to explore the potential expansionary effect stemming from the monetization of debt. We develop a simple macroeconomic model with Keynesian features and four sectors: creditor households, debtor households, businesses, and the public sector. We show that such expansionary effect stems mainly from a reduction in the financial cost of servicing the public debt. The efficacy of the channel that allegedly operates through the compression of the risk/term premium on securities is found to be ambiguous. Finally, we show that a country that issues its own currency can avoid becoming stuck in a structural “liquidity trap,” provided its central bank is willing to monetize the debt created by a strong enough fiscal expansion.

Number of Pages in PDF File: 30

Keywords: Floor System, Debt Monetization, Functional Finance, Policy Coordination, Neutral Interest Rate

JEL Classification: E10, E12, E44, E52, E58

working papers series