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Banking and interest rates in monetary policy analysis: A quantitative exploration

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  • Goodfriend, Marvin
  • McCallum, Bennett T.

Abstract

The paper reconsiders the role of money and banking in monetary policy analysis by including a banking sector and money in an optimizing model otherwise of a standard type. The model is implemented quantitatively, with a calibration based on U.S. data. It is reasonably successful in providing an endogenous explanation for substantial steady-state differentials between the interbank policy rate and (i) the collateralized loan rate, (ii) the uncollateralized loan rate, (iii) the T-bill rate, (iv) the net marginal product of capital, and (v) a pure intertemporal rate. We find a differential of over 3 % pa between (iii) and (iv), thereby contributing to resolution of the equity premium puzzle. Dynamic impulse response functions imply pro-or-counter-cyclical movements in an external finance premium that can be of quantitative significance. In addition, they suggest that a central bank that fails to recognize the distinction between interbank and other short rates could miss its appropriate settings by as much as 4% pa. Also, shocks to banking productivity or collateral effectiveness call for large responses in the policy rate.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 54 (2007)
Issue (Month): 5 (July)
Pages: 1480-1507

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Handle: RePEc:eee:moneco:v:54:y:2007:i:5:p:1480-1507

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Web page: http://www.elsevier.com/locate/inca/505566

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  1. Ireland, Peter N, 2004. "Money's Role in the Monetary Business Cycle," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 36(6), pages 969-83, December.
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