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Credit and the Natural Rate of Interest

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  • FIORELLA DE FIORE
  • ORESTE TRISTANI

Abstract

We analyze the properties of the natural rate of interest in an economy where nominal debt contracts generate a spread between loan rates and the policy interest rate. In our model, monetary policy has real effects in the flexible-price equilibrium, because it affects the credit spread. Relying on a definition suitable for this environment, we demonstrate that: (i) the natural rate is independent of monetary policy and (ii) it delivers price stability, if used as the intercept of a monetary policy rule. The second result holds exactly if real balances are remunerated at a constant spread below policy interest rates, approximately otherwise. We also highlight, however, that the natural rate is not robust to model un-certainty. The natural rate reacts differently to aggregate shocks - not only quantitatively but also qualitatively - depending on the underlying model assumptions (e.g. whether or not financial markets are frictionless). JEL Classification: E40, E50, G10

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Bibliographic Info

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

Volume (Year): 43 (2011)
Issue (Month): (03)
Pages: 407-440

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Handle: RePEc:mcb:jmoncb:v:43:y:2011:i::p:407-440

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

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  1. Timothy S. Fuerst & Charles T. Carlstrom, 1998. "Agency costs and business cycles," Economic Theory, Springer, vol. 12(3), pages 583-597.
  2. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," NBER Working Papers 8403, National Bureau of Economic Research, Inc.
  3. Queijo, Virginia, 2005. "How Important are Financial Frictions in the U.S. and Euro Area?," Seminar Papers 738, Stockholm University, Institute for International Economic Studies.
  4. Andrew T. Levin & Fabio M. Natalucci & Egon Zakrajsek, 2004. "The magnitude and cyclical behavior of financial market frictions," Finance and Economics Discussion Series 2004-70, Board of Governors of the Federal Reserve System (U.S.).
  5. Gale, Douglas & Hellwig, Martin, 1985. "Incentive-Compatible Debt Contracts: The One-Period Problem," Review of Economic Studies, Wiley Blackwell, vol. 52(4), pages 647-63, October.
  6. Carlstrom, Charles T & Fuerst, Timothy S, 1997. "Agency Costs, Net Worth, and Business Fluctuations: A Computable General Equilibrium Analysis," American Economic Review, American Economic Association, vol. 87(5), pages 893-910, December.
  7. Marvin J. Barth III & Valerie A. Ramey, 2002. "The Cost Channel of Monetary Transmission," NBER Chapters, in: NBER Macroeconomics Annual 2001, Volume 16, pages 199-256 National Bureau of Economic Research, Inc.
  8. Ravenna, Federico & Walsh, Carl E., 2006. "Optimal monetary policy with the cost channel," Journal of Monetary Economics, Elsevier, vol. 53(2), pages 199-216, March.
  9. Ben Bernanke & Mark Gertler & Simon Gilchrist, 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," NBER Working Papers 6455, National Bureau of Economic Research, Inc.
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Cited by:
  1. Woon Gyu Choi & David Cook, 2010. "Fire Sales and the Financial Accelerator," IMF Working Papers 10/141, International Monetary Fund.
  2. Otmar Issing, 2009. "In search of monetary stability: the evolution of monetary policy," BIS Working Papers 273, Bank for International Settlements.
  3. De Fiore, Fiorella & Tristani, Oreste, 2009. "Optimal monetary policy in a model of the credit channel," Working Paper Series 1043, European Central Bank.
  4. Kobayashi, Teruyoshi, 2009. "Firm entry and monetary policy transmission under credit rationing," MPRA Paper 17553, University Library of Munich, Germany.
  5. Claudio Borio & Piti Disyatat, 2011. "Global imbalances and the financial crisis: Link or no link?," BIS Working Papers 346, Bank for International Settlements.
  6. Olmos, Lorena & Sanso Frago, Marcos, 2014. "Natural Rate of Interest with Endogenous Growth, Financial Frictions and Trend Inflation," MPRA Paper 57212, University Library of Munich, Germany.

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