The Economics Of Monetary Markets

Caballero and Simsek develop a macroeconomic mannequin to analyze the effectiveness of large-scale asset purchases . The model options risk-tolerant (“banks”) and risk-intolerant (“households”) investors. In equilibrium, banks are levered and extremely exposed to aggregate shocks, such as the adverse provide shock because of COVID-19. In response to such a shock, the efficient risk tolerance of the market falls, and the required Sharpe ratio rises. If the shock is small and momentary, a small increase within the Sharpe ratio suffices for monetary markets to clear. If the shock is giant, nevertheless, even whether it is momentary, the required enhance in the Sharpe ratio is giant, and the decline in asset costs and aggregate demand may exceed the decline in provide.

Khaterine William

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