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Credit Market Distortions, Asset Prices and Monetary Policy

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  • Pfajfar, D.
  • Santoro, E.

    (Tilburg University, Center for Economic Research)

Abstract

Abstract: We study the conditions that ensure rational expectations equilibrium (REE) determinacy and expectational stability (E-stability) in a standard sticky-price model augmented with the cost channel. We allow for varying degrees of pass-through of the policy rate to bank-lending rates. Strong cost-side effects heavily constrain the policy rate response to inflation from above, so that inflation tar- geting policies may not be capable of ensuring REE uniqueness. In such cases, it is advisable to combine inflation responses with an appropriate reaction to the output gap and/or firm profitability. The negative reaction of real activity and asset prices to inflationary shocks adds a negative force to inflation responses that counteracts the borrowing cost effect and avoids expectations of higher inflation to become self-fulfilling.

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Bibliographic Info

Paper provided by Tilburg University, Center for Economic Research in its series Discussion Paper with number 2012-010.

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Date of creation: 2012
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Handle: RePEc:dgr:kubcen:2012010

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Web page: http://center.uvt.nl

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Keywords: Monetary Policy; Cost Channel; Asset Prices; Determinacy; E-stability;

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Citations

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Cited by:
  1. Evans, George W & Honkapohja, Seppo, 2008. "Expectations, Learning and Monetary Policy: An Overview of Recent Rersearch," CEPR Discussion Papers 6640, C.E.P.R. Discussion Papers.
  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," EconStor Preprints 95230, ZBW - German National Library of Economics.
  4. 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.
  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. Tamborini, Roberto, 2008. "The "Credit-Cost Channel" of Monetary Policy. A Theoretical Assessment," Economics Discussion Papers 2008-33, Kiel Institute for the World Economy.

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