Monetary Policy Trade-Offs in a Portfolio Model with Endogenous Asset Supply

Domestic producers choose an optimal capital structure and finance capital goods through credit, bonds and equity assets. Private households hold a portfolio of domestic and foreign assets, shift balances depending on risk-return considerations, and maximise real consumption in accordance with the law of one price.

Within this general equilibrium model, it will be shown that central bank interventions may promote an inefficient international allocation of real capital. The application of expansive monetary interventions throughout the course of economic crises maintains the domestic stock of real capital at the cost of inflation, currency devaluation, distortions of interest rates and asset prices, and risk clusters on the central bank’s balance sheet.