Quantitative Easing and Direct Lending in Response to the COVID-19 Crisis
When the COVID-19 crisis hit the economy in 2020, the Federal Reserve responded with numerous programs designed to prevent a collapse in bank credit and firms’ available funds. I develop a dynamic general equilibrium model to study how these programs work and to evaluate their effectiveness. In the model, quantitative easing works through three channels: the expansion of bank reserves lowers a liquidity premium, the purchase of assets lowers a volatility risk premium, and the economic stimulus lowers a credit risk premium. Since bank reserves are currently larger than in the past, the liquidity premium channel is weaker, and quantitative easing is less effective. Direct lending to firms at a market rate is also less effective. Direct lending to firms at a subsidized rate can be more stimulative than quantitative easing, provided that it lowers firms’ marginal borrowing rate and user cost of capital.
Occhino, Filippo 2020. “Quantitative Easing and Direct Lending in Response to the COVID-19 Crisis” Federal Reserve Bank of Cleveland, Working Paper No. 20-29. https://doi.org/10.26509/frbc-wp-202029