Florencia Airaudo, Universidad Carlos lll (Job Market Seminar)

"Exit Strategies from Quantitative Easing: the role of the fiscal-monetary policy mix"


As a consequence of the policy responses to the COVID-19 crisis, central bank balance sheets, public debt, and liquidity increased in many developed economies. As the economies recover and inflation far exceeds the target, central banks face a challenge in how to manage their balance sheet. I study the macroeconomic effects of reducing the central bank balance sheet size, i.e., Quantitative Tightening (QT). I construct a Regime-Switching New Keynesian DSGE model calibrated to the US economy. The economy fluctuates between a monetary-led regime, a fiscally-led regime, and the zero lower bound on the monetary policy interest rate. The macroeconomic effects of QT crucially depend on the fiscal-monetary policy mix. In a monetary-led regime, QT effectively reduces inflation at the cost of increasing the government debt-to-GDP ratio. In contrast, unwinding the central bank balance sheet in a fiscally-led regime has little impact on inflation. The negative demand effect driven by QT is not enough to counteract the stimulative impact of negative real interest rates and fiscal stimulus.

Contact person: Søren Hove Ravn