Seminar 237, Monetary Policy, Financial Crises, and the Limits to Arbitrage

Seminar | September 4 | 2:10-3:30 p.m. | 597 Evans Hall

 Walker Ray, University of California - Berkeley

 Department of Economics

With conventional monetary policy unable to stabilize the economy in the wake of the global financial crisis, central banks turned to unconventional tools. This paper embeds a model of the term structure of interest rates featuring market segmentation and limits to arbitrage within a New Keynesian model to study these policies. Because the transmission of monetary policy depends on private agents with limited risk-bearing capacity, financial market disruptions reduce the efficacy of both conventional policy as well as forward guidance. Conversely, financial crises are exactly the time when large scale asset purchases are most effective. Policymakers can take advantage of the inability of financial markets to fully absorb these purchases, which can push down long-term interest rates and help stabilize output and inflation.

 Nick Sander, Macroeconomics Seminar Coordinator, Department of Economics,