Policy Rules in Times of Prolonged Crisis: Quantitative Easing Abroad and Fiscal Adjustment at Home

Abstract

This paper examines the international transmission of real and financial shocks which originate in, and are partially offset by, quantitative easing in a large financially-stressed country. Using a two-country model, we evaluate the adjustment in the non-stressed foreign country, following recurring negative shocks (to productivity or financial net worth or both), and the application of QE policies in the stressed country. We find that the non-stressed country can make effective use of tax-rate changes to stabilize asset prices, consumption and investment during the crisis pe-riod abroad, if the crisis is generated by productivity shocks or financial shocks, or both. The tax-rate regime in the non-stressed country works best, by generating positive externalities for the stressed country in the face of recurring productivity shocks. Under recurring financial net-worth shocks, the benefit ts of the tax-rate regime are less global, and more local, more confined to the non-stressed country.