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Default and determinacy under quantitative easing

Abstract

We show that the path of inflation under quantitative easing policies that target interest rates, is determinate in the presence of default. We achieve this through different payoff profiles that a collateralised defaultable bond achieves in different states of nature with distinct default outcomes. In the model, heterogeneous households trade this bond and other shorter maturity risk-free bonds to maximize their intertemporal utility of consumption and labour. The differentiated payoffs of the collateralised bond, in an equilibrium with active default, span the full state space giving determinacy of prices and inflation as an outcome. This, implies that quantitative easing as implemented by the ECB in the recent years, can control the stochastic path of inflation.

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Correspondence to Dimitrios P. Tsomocos.

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We are grateful to John Geanakoplos, Christina Laskaridis, Theofanis Papamichalis, Udara Peiris, Heracles Polemarchakis, two anonymous referees and seminar participants at the Summer Workshop in Economic Theory (SWET19) in memory of Martine Quinzii for their valuable comments. However, all remaining errors are ours.

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Romanidis, N., Tsomocos, D.P. Default and determinacy under quantitative easing. Econ Theory (2021). https://doi.org/10.1007/s00199-021-01365-6

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  • DOI: https://doi.org/10.1007/s00199-021-01365-6

Keywords

  • Default
  • Collateral
  • Determinacy
  • Money
  • Quantitative easing

JEL Classification:

  • D53
  • E44
  • D58