Credit market distortions, asset prices and monetary policy
Pfajfar,D. Santoro,E.
Pfajfar,D.
Santoro,E.
Abstract
We study the conditions that ensure rational expectations equilibrium (REE) determinacy and expectational stability (E-stability) in a standard sticky-price model augmented with the cost channel. We allow for varying degrees of pass-through of the policy rate to bank-lending rates. Strong cost-side effects limit the size of the policy rate response to inflation that is consistent with determinacy, so that inflation-targeting policies may not be capable of ensuring REE uniqueness. In this case it is advisable to combine policy rate responses to inflation with an appropriate reaction to the output gap and/or firm profitability. The negative reaction of real activity and asset prices to inflationary shocks adds a negative force to inflation responses that counteracts the borrowing cost effect and prevents expectations of higher inflation from becoming self-fulfilling.
Description
Date
2014-04
Journal Title
Journal ISSN
Volume Title
Publisher
Research Projects
Organizational Units
Journal Issue
Keywords
Monetary policy, cost channel, asset prices, Determinacy, E-stability, SDG 17 - Partnerships for the Goals
Citation
Pfajfar, D & Santoro, E 2014, 'Credit market distortions, asset prices and monetary policy', Macroeconomic Dynamics, vol. 18, no. 3, pp. 631-650. https://doi.org/10.1017/S1365100512000557