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Credit Market Distortions, Asset Prices and Monetary Policy

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  • Pfajfar, D.
  • Santoro, E.

Abstract

In this paper we develop a sticky price DSGE model to study the role of capital market imperfections for monetary policy implementation. Recent empirical and theoretical studies have stressed the e¤ect of .rms.external .nance on their pricing decisions. The so-called cost channel of the transmission mechanism has been explored within New Keynesian frameworks that pose particular emphasis on in.ation dynamics. These models generally disregard the role of external .nance for the dynamics of asset prices. We ask whether monetary policy should respond to deviations of asset prices from their frictionless level and, more importantly, if the answer to this question changes when financial frictions are properly taken into account. We analyze these issues from the vantage of equilibrium determinacy and stability under adaptive learning. We show that usual conditions for equilibrium uniqueness and E-stability are significantly altered when the cost channel matters. Nevertheless, we find that responding to actual or expected asset price misalignments helps at restoring determinacy and stability under learning. These conclusions are further enforced in the presence of a high degree of pass-through from policy to bank lending rates.

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Bibliographic Info

Paper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 0825.

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Length: 24
Date of creation: Apr 2008
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Handle: RePEc:cam:camdae:0825

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Keywords: Monetary Policy; Capital Market Imperfections; Cost Channel; Asset Price.;

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Citations

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Cited by:
  1. Tamborini, Roberto, 2009. "The "Credit-Cost Channel" of Monetary Policy. A Theoretical Assessment," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy, vol. 3(13), pages 1-23.
  2. Pfajfar, Damjan & Santoro, Emiliano, 2011. "Determinacy, stock market dynamics and monetary policy inertia," Economics Letters, Elsevier, vol. 112(1), pages 7-10, July.
  3. Tayler, William & Zilberman, Roy, 2014. "Macroprudential Regulation and the Role of Monetary Policy," Dynare Working Papers 37, CEPREMAP.
  4. George W. Evans & Seppo Honkapohja, 2008. "Expectations, Learning, And Monetary Policy: An Overview Of Recent Research," Working Papers Central Bank of Chile 501, Central Bank of Chile.
  5. Vicente da Gama Machado, 2012. "Monetary Policy, Asset Prices and Adaptive Learning," Working Papers Series 274, Central Bank of Brazil, Research Department.
  6. Machado, Vicente da Gama, 2013. "Monetary policy rules, asset prices and adaptive learning," Journal of Financial Stability, Elsevier, vol. 9(3), pages 251-258.
  7. Pfajfar, D. & Zakelj, B., 2011. "Inflation Expectations and Monetary Policy Design: Evidence from the Laboratory (Replaces CentER DP 2009-007)," Discussion Paper 2011-091, Tilburg University, Center for Economic Research.

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