Central Bank Balance Sheet Policies Without Rational Expectations

64 Pages Posted: 6 Aug 2018

See all articles by Luigi Iovino

Luigi Iovino

Massachusetts Institute of Technology (MIT)

Dmitriy Sergeyev

Bocconi University

Date Written: August 2018

Abstract

We study the effects of central bank balance sheet policies-namely, quantitative easing and foreign exchange interventions-in a model where people form expectations through the level-k thinking process, which is consistent with experimental evidence on the behavior of people in strategic environments. We emphasize two main theoretical results. First, under a broad set of conditions, central bank interventions are effective under level-k thinking, while they are neutral in the rational expectations equilibrium. Second, forecast errors about future endogenous variables are predictable by balance sheet interventions. We confirm these predictions using data on mortgage purchases by US government sponsored enterprises.

Suggested Citation

Iovino, Luigi and Sergeyev, Dmitriy, Central Bank Balance Sheet Policies Without Rational Expectations (August 2018). CEPR Discussion Paper No. DP13100, Available at SSRN: https://ssrn.com/abstract=3226875

Luigi Iovino (Contact Author)

Massachusetts Institute of Technology (MIT) ( email )

77 Massachusetts Avenue
50 Memorial Drive
Cambridge, MA 02139-4307
United States

Dmitriy Sergeyev

Bocconi University ( email )

Via Sarfatti, 25
Milan, MI 20136
Italy

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