Credit and the natural rate of interest
AbstractWe 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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Date of creation: Apr 2008
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Other versions of this item:
- E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
- E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
- G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-05-31 (All new papers)
- NEP-CBA-2008-05-31 (Central Banking)
- NEP-MAC-2008-05-31 (Macroeconomics)
- NEP-MON-2008-05-31 (Monetary Economics)
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