Quantitative Easing and Government Debt Sustainability

We show that quantitative easing (QE) worsens government debt sustainability.In our model, the government has a negative primary balance and downward-sloping debt demand that makes interest rates endogenous.The central bank has long-term capital and remits profits to the fiscal authority.QE depletes this capital stock, reducing future remittances and crisis-fighting reserves.Contrary to Sargent and Wallace (1981), where greater monetary accommodation lowers the steady-state debt level, we show that QE increases the steady-state level of debt and shifts the default boundary inward, thus heightening fragility and reducing debt sustainability.Moreover, while QE can keep interest rates low for extended periods, sustaining a QE-backed rate peg requires a growing central-bank footprint and accelerating capital depletion, until financing costs rise sharply.Under certain parameters, large-scale QE makes previously sustainable debt levels unsustainable, leading ultimately to sovereign default.