Inside the Great Escape: a quantitative analysis considering the eligibility criteria of the Fed’s liquidity facilities

Abstract

This paper re-evaluates the macroeconomic impact of the Federal Reserve’s liquidity provision facilities implemented during the onset of the Great Recession. I build on Del Negro, Eggertsson, Ferrero and Kiyotaki to lift an assumption in their DSGE model with nominal rigidities, real rigidities and liquidity frictions to include a mechanism that accounts for the eligibility criteria of the unconventional monetary policy. I will lift an assumption which will split the liquidity friction in two, one affecting the assets and one affecting the liabilities of the household. Therefore, the unconventional monetary policy of the model will respond with aggregate liquidity upon the shock in the assets markets, but not upon stress in the liabilities markets. I obtain numerical results that are compared with the data and with the authors’ model results. My results support their findings as the effects of the liquidity shock are large. It explains about 50% of the drop in output and roughly 75% of the drop in inflation after Lehman bankruptcy. My findings also reinforce the result of the authors that the liquidity facilities of the Federal Reserve prevented the economy of going through an episode resembling the Great Depression. However, there are quantitative effects of the eligibility criteria as the gains might be slightly overestimated. Through a deep dive in the eligibility criteria effect I find that unconventional monetary policy can be inflationary and that it has no effect if it is targeted to markets which are not stressed.