Financial Stress and Liquidity Traps
AbstractMotivated by the bubble-collapse cycle witnessed in Japanese asset prices since the late 1980s, this paper examines how a financial crisis influences the power of monetary policy. We construct a simple macroeconomic model based on the microfoundations of Holmstrom and Tirole (1997) to analyse the effect of three types of financial stress on the nature of the equilibrium: a credit crunch; an adverse collateral shock; and a monitoring cost shock. Perhaps surprisingly, we find that the power of monetary policy is, if anything, heightened in a credit crunch; higher monitoring costs however work in the opposite direction, suggesting a need for more aggressive stabilisation policy in the face of financial shocks.
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Bibliographic InfoPaper provided by Royal Economic Society in its series Royal Economic Society Annual Conference 2002 with number 2.
Date of creation: 29 Aug 2002
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This paper has been announced in the following NEP Reports:
- NEP-ALL-2002-07-08 (All new papers)
- NEP-FIN-2002-07-08 (Finance)
- NEP-IFN-2002-07-08 (International Finance)
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