Real Consequences of Open Market Operations: The Role of Limited Commitment

Abstract

We study how limited commitment in credit markets affects the implementation of open market operations and characterize when they result in real indeterminacies and when they have real effects. To do so, we consider a frictional and incomplete market framework where agents face stochastic trading opportunities and limited commitment in some markets. When limited commitment does not constraint agents’ choices, we find necessary and sufficient conditions for the existence of a unique monetary equilibrium. However, real indeterminacies are possible when buyers face a binding no-default constraint. We also show that when the no-default constraint binds and bonds are not priced fundamentally, open market operations generically have real effects. A sale of government bonds can increase or decrease interest rates, depending on the nature of equilibria. The direction of the interest rate effects critically depend on the size of the liquidity premium on government bonds. Finally, government bonds purchases can be used to rule out real indeterminacies, thus finding another rationale for such policy.

About the presenter’s visit

Dr Francesco Carli be visiting the School of Economics on Wednesday 25^th September 2019. While here he will be using room 520A Colin Clark Building. If you would like to meet with him or have lunch or dinner with him please contact Dr Jorge Miranda Pinto who will be his host while at The University of Queensland. Dr Miranda Pinto can be contacted on j.mirandapinto@uq.edu.au.