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Banking competition, collateral constraints and optimal monetary policy

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Author Info

  • Javier Andrés

    ()
    (Universidad de Valencia)

  • Óscar Arce

    (CNMV)

  • Carlos Thomas

    ()
    (Banco de España)

Abstract

We analyze optimal monetary policy in a model with two distinct financial frictions. First, borrowing is subject to collateral constraints. Second, credit flows are intermediated by monopolistically competitive banks, thus giving rise to endogenous lending spreads. We show that, up to a second order approximation, welfare maximization is equivalent to stabilization of four goals: inflation, output gap, the consumption gap between constrained and unconstrained agents, and the distribution of the collateralizable asset between both groups. Following both financial and non-financial shocks, the optimal monetary policy commitment implies a short-run trade-off between stabilization goals. Such policy tradeoffs become amplified as banking competition increases, due to the fall in lending spreads and the resulting increase in financial leveraging.

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File URL: http://www.bde.es/f/webbde/SES/Secciones/Publicaciones/PublicacionesSeriadas/DocumentosTrabajo/10/Fic/dt1001e.pdf
File Function: First version, February 2010
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Bibliographic Info

Paper provided by Banco de Espa�a in its series Banco de Espa�a Working Papers with number 1001.

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Length: 45 pages
Date of creation: Feb 2010
Date of revision:
Handle: RePEc:bde:wpaper:1001

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Keywords: banking competition; lending spreads; collateral constraints; monetary policy; linear-quadratic method;

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