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Banking and Interest Rates in Monetary Policy Analysis: A Quantitative Exploration

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  • Marvin Goodfriend
  • Bennett T. McCallum

Abstract

The paper reconsiders the role of money and banking in monetary policy analysis by including a banking sector and money in an optimizing model otherwise of a standard type. The model is implemented quantitatively, with a calibration based on U.S. data. It is reasonably successful in providing an endogenous explanation for substantial steady-state differentials between the interbank policy rate and (i) the collateralized loan rate, (ii) the uncollateralized loan rate, (iii) the T-bill rate, (iv) the net marginal product of capital, and (v) a pure intertemporal rate. We find a differential of over 3 % pa between (iii) and (iv), thereby contributing to resolution of the equity premium puzzle. Dynamic impulse response functions imply pro-or-counter-cyclical movements in an external finance premium that can be of quantitative significance. In addition, they suggest that a central bank that fails to recognize the distinction between interbank and other short rates could miss its appropriate settings by as much as 4% pa. Also, shocks to banking productivity or collateral effectiveness call for large responses in the policy rate.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13207.

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Date of creation: Jun 2007
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Publication status: published as Goodfriend, Marvin & McCallum, Bennett T., 2007. "Banking and interest rates in monetary policy analysis: A quantitative exploration," Journal of Monetary Economics, Elsevier, vol. 54(5), pages 1480-1507, July.
Handle: RePEc:nbr:nberwo:13207

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  7. Bennett T. McCallum, 2002. "Recent developments in monetary policy analysis: the roles of theory and evidence," Economic Quarterly, Federal Reserve Bank of Richmond, Federal Reserve Bank of Richmond, issue Win, pages 67-96.
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