The effect of asset purchase programmes on real economy: a simulation of covid-19

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School of Business | Master's thesis
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Date

2022

Department

Taloustieteen laitos

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Mcode

Degree programme

Economics

Language

en

Pages

61+1

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Abstract

Quantitative easing has been an important part of central banks’ toolkits for almost two decades. In the US, this monetary policy tool has been used to complement the conventional policies that proved to be insufficient as the nominal interest rates fell close to zero levels in the aftermath of the global financial crisis. During the past fifteen years, the importance of quantitative easing has only grown and until today, the Federal Reserve has purchased assets worth a total of trillions of dollars, with an aim to reduce the interest rates and stimulate the economy. The effectiveness of these asset purchases has been a topic of vast interest among economists ever since the central banks first introduced it to their toolkits, and a large amount of research focuses on modelling their functioning and impact on real economy. This thesis presents a New Keynesian dynamic stochastic general equilibrium (DSGE) model that is implemented to evaluate the effects of quantitative easing on real economy. The model used in this thesis exhibits imperfect asset substitutability between government bonds of different maturities and a feedback effect from the term structure to the macroeconomy according to Matteo Falagiarda (2014). As a result, the model is able to capture the portfolio rebalancing channel of quantitative easing. The aim is to simulate an economy that is affected by a positive monetary policy shock in the form of large-scale asset purchases and to study the impacts of the shock on the real economy. To make the setting more realistic and current, the model is calibrated to reflect the US economy after the early 2020, when the Covid-19 pandemic reached the country and forced the Federal Reserve to go to new lengths in its efforts to combat the low-interest rate economy and expand its asset purchase programmes. The simulation is conducted by implementing the DSGE model into the MATLAB programming tool. The simulations run in MATLAB include a baseline scenario, where the US economy faces a positive monetary policy shock of a large-scale asset purchase shock, and a Covid-19 scenario, where the US economy also faces a negative productivity shock that illustrates the initial supply shock caused by the Covid-19 pandemic. The results of the simulations are consistent with earlier literature and empirics: large-scale asset purchases conducted by the Federal Reserve of the US were able to reduce the long-term rate and the term premium and increase output and inflation in the economy. Even combined with the negative effects of the Covid-19 shock, these asset purchases were effective in mitigating the negative impacts on the US economy, at least in the medium term. To check for the robustness of the results, a sensitivity analysis is conducted replicating the simulations with varying levels of magnitude and persistence of the shocks.

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Thesis advisor

Honkapohja, Seppo

Keywords

monetary policy, Federal Reserve, quantitative easing, asset purchase programme, covid-19, DSGE model, new Keynesian monetary economics

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https://urn.fi/URN:NBN:fi:aalto-202209045286

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[gradu] Kauppakorkeakoulu / BIZ