The Theory of Unconventional Monetary Policy

Roger Farmer, Pawel Zabczyk

NBER Working Paper No. 22135
Issued in March 2016
NBER Program(s):   AP   EFG   ME 

This paper is about the effectiveness of qualitative easing, a form of unconventional monetary policy that changes the risk composition of the central bank balance sheet with the goal of stabilizing economic activity. We construct a general equilibrium model where agents have rational expectations and there is a complete set of financial securities, but where some agents are unable to participate in financial markets. We show that a change in the risk composition of the central bank's balance sheet will change equilibrium asset prices and we prove that, in our model, a policy in which the central bank stabilizes non-fundamental fluctuations in the stock market is Pareto improving and self-financing.