Lorenzo Burlon

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"Inflation, financial conditions and non-standard monetary policy in a monetary union. A model-based evaluation"

Joint with Andrea Gerali, Alessandro Notarpietro, and Massimiliano Pisani.

First version: June 2015.

Abstract This paper evaluates the macroeconomic effects of purchases of long-term sovereign bonds by a central bank in a monetary union when (1) the private sector faces tight financial conditions and (2) the zero lower bound (ZLB) on the policy rate holds. To this end, we calibrate a dynamic general equilibrium model to the euro area (EA). We assume that households in one member country have a large initial debt position and are subject to a borrowing constraint. We simulate the effects of a negative EA-wide demand shock that induces a decline in inflation. The main results are as follows. First, the reduction in inflation amplifies the domestic and cross-country spillovers of the negative demand shock because of the country-specific borrowing constraint and the ZLB. Second, sovereign bond purchases boost economic activity and, hence, indirectly allow households to reduce their debt and relax the borrowing constraint. Third, the new, lower value of debt allows households to smooth consumption, fostering macroeconomic resilience not only in the member country concerned but also in the rest of the monetary union.

Keywords: DSGE models, financial frictions, open-economy macroeconomics, non-standard monetary policy, zero lower bound.

JEL classifications: E43, E44, E52, E58.

Working paper versions:

Temi di discussione (Working papers) 1015, Bank of Italy (2015).

Press releases:

- "Understanding Inflation Dynamics and Monetary Policy in a Low Inflation Environment," Remarks by Vítor Constâncio, Vice-President of the European Central Bank at the ECB Conference on "Challenges for Macroeconomic Policy in a Low Inflation Environment," Frankfurt, 5 November 2015.

- "Why is Eurozone inflation so low?," Stefano Neri and Stefano Siviero, World Economic Forum, 18 August 2015.

- "Low inflation in the Eurozone," Stefano Neri and Stefano Siviero, VoxEu, 15 August 2015.


- Workshop on "Low inflation and its implications for monetary policy," Bank of Italy, October 2015.
- Workshop on "Deflation - Causes, Consequences and Policies," Sveriges Riksbank, June 2015 (Massimiliano Pisani).
- III internal workshop of the Bank of Italy's Economic Outlook and Monetary Policy Directorate, Bank of Italy, March 2015 (Massimiliano Pisani).