Abstract:
We examine the potential effectiveness of asset purchases (AP) in small open economies. To that end we extend the model of Gertler and Karadi (2011) to a small open economy, in which households and firms can borrow and lend in the global. financial market. Our results confirm a previous finding of the literature: In a small open economy, the response of the main variables to AP is weaker than in a closed economy. However, this weaker response does not necessarily imply a weaker benefit of AP: We show that even in a small open economy AP can improve welfare, and that the improvement could potentially be larger than in a closed economy. The reason is that conducting AP allows the economy to restore a more efficient financing structure, in the sense that it reduces intermediation costs paid to foreign lenders.
JEL classification: E32,E44,E52,F41.
Keywords: small-open economy, unconventional monetary policy, financial fric-tions, asset purchases, welfare. Bank of Israel.