Non-Neutrality of Open-Market Operations Pierpaolo Benigno (LUISS Guido Carli and EIEF) and Salvatore Nisticò (“Sapienza” Università di Roma) CEP-Gerzensee-SNB Workshop Gerzensee, November 9–10, 2017 Benigno and Nisticò Non-Neutrality of Open-Market Operations Nov 9–10, 2017 1 / 30
Motivation “Old-Style” vs “New-Style” Central Banking Several central banks around the world (Bank of England, Bank of Japan, ECB, Fed, Riksbank) are holding risky securities in their balance sheets as a consequence of unconventional open-market operations (like LSAP’s). Main question : Do purchases of risky securities have any effect on output and inflation? Is unconventional policy an additional dimension of monetary policy? 1 Are there any consequences on equilibrium output and inflation of the 2 possible income losses on risky securities? A negative answer points toward the irrelevance ( “neutrality” ) of OMO’s. Benigno and Nisticò Non-Neutrality of Open-Market Operations Nov 9–10, 2017 2 / 30
Neutrality Property Neutrality Property: Given a conventional monetary and fiscal policy , all alternative CB balance-sheet compositions/sizes are consistent with the same equilibrium paths of output and prices. ⇒ Open-market operations are irrelevant for equilibrium output and inflation. Main intuition : if the central bank bears some risk that was before in the hands of the private sector, the materialization of that risk does not affect equilibrium output and inflation if it is ultimately borne by the private sector. Neutrality granted by specific transfer policies: between treasury and private sector 1 between central bank and treasury (key is the separation of treasury 2 and central bank balance sheets) Benigno and Nisticò Non-Neutrality of Open-Market Operations Nov 9–10, 2017 3 / 30
Main results Neutrality Property holds: 1 passive fiscal policy, and passive remittances’ policy (or full treasury’s support) Non-neutrality case I: 2 passive fiscal policy, and absence of treasury support IF losses are significant in size Non-neutrality case II: 3 passive fiscal policy, and central bank’s commitment to financial independence Non-neutrality case III: 4 active fiscal policy ⇒ LSAPs as a way to implement helicopter money Non-neutral OMOs to escape suboptimal policies during a liquidity trap 5 Benigno and Nisticò Non-Neutrality of Open-Market Operations Nov 9–10, 2017 4 / 30
Related Literature Propositions of Neutrality (Wallace, 1981, Chamley and Polemarchakis, 1984, Sargent and Smith, 1987, Eggertsson and Woodford, 2003); Relationship between central bank’s financial strength and objectives of monetary policy (Sims, 2000, 2005, Del Negro and Sims, 2014, Stella 1997, 2005, Reis 2015); Implications of accounting procedures and remittance policies for central bank’s solvency (Bassetto and Messer, 2013; Hall and Reis 2013); Fiscal Theory of the Price Level (Sargent and Wallace, 1981, Sargent, 1982, Leeper, 1991; Sims, 1994,2013; Woodford, 1995; Cochrane, 2001, 2005). Signalling effects of QE (Krishnamurthy and Vissing-Jorgensen, 2011; Woodford, 2012; Bhattarai, Eggertsson and Gafarov, 2015) Benigno and Nisticò Non-Neutrality of Open-Market Operations Nov 9–10, 2017 5 / 30
Intuition: a simple endowment economy Equilibrium in the money market: M t ≥ Y t ; (1) P t Euler Equation: � � βξ t + 1 U c ( Y t + 1 ) 1 P t = E t , (2) 1 + i t ξ t U c ( Y t ) P t + 1 Conventional monetary policy specifies one between { i t , M t } as a function of other variables: I ( · ) or M ( · ) “REE”: a collection of stochastic processes { Π t , i t , M t } satisfying equations (1)-(2) consistently with the specification of conventional monetary policy and subject to i t ≥ 0, given exogenous processes { Y t , ξ t } Benigno and Nisticò Non-Neutrality of Open-Market Operations Nov 9–10, 2017 6 / 30
Intuition: a simple endowment economy Given the “equilibrium” processes { Π t , i t , M t } one can evaluate the pricing kernel R t , T = β T − t ξ T U c ( Y T ) (3) ξ t U c ( Y t ) that prices long-term securities (with decaying geometric coupons and subject to exogenous default risk κ ) � � R t , t + 1 ( 1 − κ t + 1 )( 1 + δ Q t + 1 ) Q t = E t (4) Π t + 1 with return 1 + r t ≡ ( 1 − κ t + 1 )( 1 + δ Q t + 1 ) / Q t . (5) Benigno and Nisticò Non-Neutrality of Open-Market Operations Nov 9–10, 2017 7 / 30
Intuition: a simple endowment economy � ≡ � � � Z ∗ Π ∗ t , i ∗ t , M ∗ t , Q ∗ t , r ∗ t , R ∗ Consider a process that satisfies (1)–(5) t t , T for a given conventional MP , I ( · ) or M ( · ) : a “candidate equilibrium”. � ˜ � � � t , ˜ B C t , D C B C D C and consider alternatively and , where t t B C t : treasury bills held by the CB D C t : long-term risky securities held by the CB (private or public) � � Z ∗ These alternative balance-sheet policies are said to be “neutral” if is t still an equilibrium for the same conventional monetary policy . How could it not be, if nothing has changed in (1)–(5) or in the policy rule? � � Z ∗ Other conditions actually need to be satisfied for to be a REE. t Benigno and Nisticò Non-Neutrality of Open-Market Operations Nov 9–10, 2017 8 / 30
Intuition: a simple endowment economy Transversality condition for households: � P t � � � M T + B T + X T lim + Q T D T = 0 (6) → ∞ E t R t , T 1 + i T P T T − where M t : currency, carrying non-pecuniary return B t : short-term treasury bills, carrying the risk-free rate i t X t : CB reserves, carrying the risk-free rate i t D t : long-term securities (private or public), bearing default risk Treasury’s flow budget constraint B F Q t D F t = ( 1 + r t ) Q t − 1 D F t − 1 + B F t − 1 − T F t − T C t + (7) t 1 + i t where T F t : primary surplus T C : remittances from CB t Benigno and Nisticò Non-Neutrality of Open-Market Operations Nov 9–10, 2017 9 / 30
Intuition: a simple endowment economy CB’s balance sheet: B C X t = Q t D C t N t + M t + t + (8) 1 + i t 1 + i t CB’s profits: Ψ t = i t − 1 ( N t − 1 + M t − 1 ) + ( r t − i t − 1 ) Q t − 1 D C (9) t − 1 Law of motion of net worth N t = N t − 1 + Ψ t − T C (10) t Asset markets equilibrium requires B F t = B t + B C (11) t D F t = D t + D C (12) t Benigno and Nisticò Non-Neutrality of Open-Market Operations Nov 9–10, 2017 10 / 30
Intuition: a simple endowment economy Under Neutrality, equations (7)–(12) can determine � ≡ � � � B t , B F t , B C t , D t , D F t , D C t , T F t , T C K t t , X t , N t , Ψ t given � ≡ � � � Z ∗ Π ∗ t , i ∗ t , M ∗ t , Q ∗ t , r ∗ t , R ∗ t t , T and exogenous processes { Y t , ξ t , κ t } if we specify (five degrees of freedom) Transfer Policies 1 � � T F t , T C specify as functions of other variables: T ( · ) t Balance-sheet Policies 2 � � B C t , D C t , D F specify as functions of other variables: B ( · ) t Benigno and Nisticò Non-Neutrality of Open-Market Operations Nov 9–10, 2017 11 / 30
Solvency Conditions and Neutrality Property � � Z ∗ is a REE if it satisfies: t solvency condition of central bank 1 + M ∗ − B C t ) Q ∗ t − 1 D C X t − 1 t − 1 t − 1 t − 1 − ( 1 + r ∗ P ∗ P ∗ P ∗ P ∗ t t t t � � ∞ i ∗ M ∗ − T C R ∗ T T T ∑ = E t (13) t , T 1 + i ∗ P ∗ P ∗ T = t T T T solvency condition of the treasury 2 � � B F t ) Q ∗ t − 1 D F ∞ T F + T C t − 1 t − 1 + ( 1 + r ∗ R ∗ t ∑ T = E t (14) P ∗ P ∗ t , T P ∗ P ∗ t t T = t T T � � Z ∗ Neutrality Property : satisfies (13)–(14), for any balance-sheet policy t � � T F t , T C Key for Neutrality is specification of transfer policies t Benigno and Nisticò Non-Neutrality of Open-Market Operations Nov 9–10, 2017 12 / 30
“Passive” Transfer Policies support Neutrality “Passive” remittances’ policy: 1 N C T C Ψ C T C + γ c t − 1 t = ¯ t + φ c (15) P t P t P t for γ c ∈ ( 0, 2 ) and φ c ∈ ( 0, 2 ) and “passive” fiscal policy: 2 � � T F T C ( 1 + r t ) Q t − 1 D F t − 1 + B F T F − γ f t − 1 t = ¯ t + φ f (16) P t P t P t for γ f = 1 and φ f ∈ ( 0, 2 ) . (16) ⇒ the treasury transfers resources to the CB in the case of losses (15) ⇒ the treasury raises these resources from the private sector ⇒ risk remains in the hands of the private sector ⇒ no wealth effects (shifts from financial to human wealth). Benigno and Nisticò Non-Neutrality of Open-Market Operations Nov 9–10, 2017 13 / 30
“Full Treasury’s Support” ( T C t = Ψ C t ) “Full Treasury’s Support” and “passive” fiscal policy satisfy Neutrality: Net worth is constant (and stationary) 1 N t = N t − 1 + Ψ C t − T C t = N t − 1 = N Interest-bearing reserves adjust appropriately 2 B C X t Q ∗ − M ∗ t D C t t + t − = N 1 + i ∗ 1 + i ∗ t t � � B C t , D C for any appropriately bounded processes . t Paying interest on reserves expands the set of neutrality cases 3 Benigno and Nisticò Non-Neutrality of Open-Market Operations Nov 9–10, 2017 14 / 30
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