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Optimal Monetary Policy in a 'Sudden Stop'

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Author Info
Fabio Braggion
Lawrence J. Christiano
Jorge Roldos

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Abstract

In the wake of the 1997-98 financial crises, interest rates in Asia were raised immediately, and then reduced sharply. We describe an environment in which this is the optimal monetary policy. The optimality of the immediate rise in the interest rate is an example of the theory of the second best: although high interest rates introduce an inefficiency wedge into the labor market, they are nevertheless welfare improving because they mitigate distortions due to binding collateral constraints. Over time, as various real frictions wear off and the collateral constraint is less binding, the familiar Friedman forces dominate, and interest rates are optimally set as low as possible.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13254.

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Date of creation: Jul 2007
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Handle: RePEc:nbr:nberwo:13254

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Find related papers by JEL classification:
E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Vasco Cúrdia, 2008. "Optimal monetary policy under sudden stops," Staff Reports 323, Federal Reserve Bank of New York. [Downloadable!]
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