Presenter: Paul Fontanier
Affiliation: Yale University, School of Management.
Date: May 7, 2024.
Time: 13:00 GMT (15:00 Israel Time)
Abstract: This paper proposes a theory of large-scale government bond purchases by central banks in an environment with endogenous information acquisition. Information acquisition by private investors lowers risk premia by reducing uncertainty, but also makes prices more sensitive to new information. This can drive the sovereign into costly roll-over crises. Asset purchases by the central bank discourage private information acquisition, impairing price informativeness. This, however, points to a benefit of such large scale programs: by implementing purchases, the central bank can avoid the occurrence of roll-over crises in the event of bad news, generating large welfare gains. A key property of the model is that substantial purchases may be required, while small interventions have ambiguous welfare consequences. When the sovereign expects the central bank to carry such programs, it leads to excessive indebtedness, forcing the central bank to run an inflated balance sheet to avoid roll-over crises.