Optimal Quantitative Easing in a Monetary Union

80 Pages Posted: 30 Nov 2020

See all articles by Serdar Kabaca

Serdar Kabaca

affiliation not provided to SSRN

Renske Maas

De Nederlandsche Bank

Kostas Mavromatis

De Nederlandsche Bank

Romanos Priftis

European Union - European Commission

Date Written: November 19, 2020

Abstract

This paper explores the optimal allocation of government bond purchases within a monetary union, using a two-region DSGE model, where regions are asymmetric with respect to economic size and portfolio characteristics: the extent of substitutability between assets of different maturity and origin, asset home bias, and steady-state levels of government debt. An optimal quantitative easing (QE) policy under commitment does not only reflect different region sizes, but is also a function of these dimensions of portfolio heterogeneity. By calibrating the model to the euro area, we show that optimal QE favors purchases from the smaller region (Periphery instead of Core), given that the former faces stronger portfolio frictions. A fully optimal policy consisting of both the short-term interest rate and QE lifts the monetary union away from the zero lower bound faster than an optimal interest rate policy alone, which entails forward guidance.

Keywords: Optimal monetary policy, quantitative easing, monetary union, DSGE model, portfolio rebalancing, zero lower bound

JEL Classification: E43, E52, E58, F45

Suggested Citation

Kabaca, Serdar and Maas, Renske and Mavromatis, Kostas and Priftis, Romanos, Optimal Quantitative Easing in a Monetary Union (November 19, 2020). De Nederlandsche Bank Working Paper No. 697, Available at SSRN: https://ssrn.com/abstract=3737379 or http://dx.doi.org/10.2139/ssrn.3737379

Serdar Kabaca

affiliation not provided to SSRN

Renske Maas

De Nederlandsche Bank ( email )

PO Box 98
1000 AB Amsterdam
Amsterdam, 1000 AB
Netherlands

Kostas Mavromatis (Contact Author)

De Nederlandsche Bank ( email )

PO Box 98
1000 AB Amsterdam
Amsterdam, 1000 AB
Netherlands

Romanos Priftis

European Union - European Commission

Rue de la Loi 200
Brussels, B-1049
Belgium

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