Abstract
Abstract This study examines the problem that a central bank may face after exiting a monetary quantitative easing policy. It develops a simple dynamic optimization model of a central bank, which finds that if the bank needs to absorb a substantial amount of excess reserves when exiting, the monetary base may become uncontrollable. In this case, the bank has no option but to increase the monetary base by more than the target amount, which leads to an undesirable money supply expansion and, ultimately, to inflation pressures. The model shows the condition when a central bank faces such a challenging situation.
Highlights
The purpose of this paper is to examine the problem that a central bank may face after exiting a monetary quantitative easing policy
This paper develops a simple dynamic optimization model of a central bank and shows that a bank’s unsound balance sheet after the exit may make it challenging for the bank to avoid an undesirable monetary base expansion
This paper has examined monetary base controllability after an exit from quantitative easing
Summary
The purpose of this paper is to examine the problem that a central bank may face after exiting a monetary quantitative easing policy. Reis (2013, 2015), Hall & Reis (2015), Del Negro & Sims (2015), Berentsen, Kraenzlin & Müller (2016), and Fujiki & Tomura (2017) study financial stability of some central banks with various exit strategies for quantitative easing under several rules concerning dividend or fund transfers to and from governments. These studies take into account the effect of a central bank’s profit on the balance sheet, but they do not drive the bank’s behaviour from optimization.
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