Unconventional Monetary Policy, Financial Frictions and the Equity Tandem

A key feature of many DSGE frameworks modeling Quantitative Easing (QE) or Unconventional Monetary Policy is that net worth only plays a relevant role on bank's balance sheets. In reality, however, net worth of borrowers and lenders plays a relevant role in financing investment projects. I argue that this equity tandem has important implications. Net worth of non-financial firms acts as a first line of defense, since non-financial firm's balance sheets are hit in the first place by real sector shocks. Modeling the equity tandem increases the resilience of the model and therefore implies smaller gains of unconventional monetary policy. A novel insight from the simultaneous modeling of borrowers and lenders net worth is that a credit or QE policy is redistributing net worth between banks and non-financial firms. In this way, unconventional policies can influence the division of the burdens between banks and non-financial firms in the aftermath of an economic downturn