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Optimal Monetary Policy in a Model with Agency Costs

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  • CHARLES T. CARLSTROM
  • TIMOTHY S. FUERST
  • MATTHIAS PAUSTIAN

Abstract

This paper integrates a fully explicit model of agency costs into an otherwise standard Dynamic New Keynesian model in a particularly transparent way. A principal result is the characterization of agency costs as endogenous markup shocks in an output-gap version of the Phillips curve. The model's utility-based welfare criterion is derived explicitly and includes a measure of credit market tightness that we interpret as a risk premium. The paper also fully characterizes optimal monetary policy and provides conditions under which zero inflation is the optimal policy. Finally, optimal policy can be expressed as an inflation targeting criterion that (depending upon parameter values) can be either forward or backward looking. Copyright (c) 2010 The Ohio State University.

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Bibliographic Info

Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 42 (2010)
Issue (Month): s1 (09)
Pages: 37-70

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Handle: RePEc:mcb:jmoncb:v:42:y:2010:i:s1:p:37-70

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Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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  1. Marvin Goodfriend & Bennett T. McCallum, 2007. "Banking and Interest Rates in Monetary Policy Analysis: A Quantitative Exploration," NBER Working Papers 13207, National Bureau of Economic Research, Inc.
  2. Matteo Iacoviello, 2005. "House Prices, Borrowing Constraints, and Monetary Policy in the Business Cycle," American Economic Review, American Economic Association, vol. 95(3), pages 739-764, June.
  3. Fiorella De Fiore & Oreste Tristani, 2013. "Optimal Monetary Policy in a Model of the Credit Channel," Economic Journal, Royal Economic Society, vol. 123(571), pages 906-931, 09.
  4. Tommaso Monacelli & Ester Faia, 2005. "Optimal Interest Rate Rules, Asset Prices and Credit Frictions," Computing in Economics and Finance 2005 452, Society for Computational Economics.
  5. Charles T. Carlstrom & Timothy S. Fuerst, 2004. "Asset prices, nominal rigidities, and monetary policy," Working Paper 0413, Federal Reserve Bank of Cleveland.
  6. Gilchrist, Simon & Leahy, John V., 2002. "Monetary policy and asset prices," Journal of Monetary Economics, Elsevier, vol. 49(1), pages 75-97, January.
  7. Benjamin Keen & Yongsheng Wang, 2007. "What is a realistic value for price adjustment costs in New Keynesian models?," Applied Economics Letters, Taylor & Francis Journals, vol. 14(11), pages 789-793.
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