Default and Determinacy Under Quantitative Easing
32 Pages Posted: 23 Oct 2019
Date Written: October 20, 2019
We show that the path of inflation under quantitative easing policies that target interest rates, is determitate in the presence of default. We achieve this through different payoff profiles that a collateralised defaultable bond achieves in different states of nature with distinct default outcomes. In the model, heterogeneous households trade this bond and other shorter maturity risk-free bonds to maximize their intertemporal utility of consumption and labour. The differentiated payoffs of the collateralised bond, in an equilibrium with active default, span the full state space giving determinacy of prices and inflation as an outcome. This, implies that quantitative easing like the one implemented by the ECB in the recent years, can control the stochastic path of inflation.
Keywords: Default, Collateral, Determinacy, Money, Quantitative Easing
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