This paper suggests a new channel through which central bank Quantitative Easing (QE) policies can amplify aggregate fluctuations. By significantly increasing excess reserve holdings in the banking sector, QE policies reduce liquidity risk and increase banks’ lending potential. Thus, disturbances that increase credit demand generate a stronger increase in lending, further amplifying the shock’s impact. We offer empirical evidence supporting this mechanism by utilizing two sources of variation in the US during the COVID-19 pandemic. First, we use cross-bank variation in mortgage-backed security (MBS) holdings to measure banks’ exposure to QE policies. Second, we use cross-state variation in the per capita Economic Impact Payments (EIP) to quantify the local aggregate demand shock stemming from pandemic-related fiscal relief. Bank-level analysis reveals that while QE is associated with an overall increase in reserves, its impact on credit expansion depends on the magnitude of the EIP-related demand shock. Additionally, state-level evidence suggests increases in credit expansion and house prices following the shock were larger in states with greater banking sector exposure to QE. The results, therefore, suggest that QE amplified the impact of government stimulus programs during COVID-19.


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