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Loan Commitments and Optimal Monetary Policy

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  • Michael Woodford

Abstract

With loan commitments negotiated in advance, the use of tight money to restrain nominal spending has asymmetric effects upon different categories of borrowers. This can reduce efficiency, even though aggregate demand is stabilized. This is illustrated in the context of an equilibrium model of financial intermediation with loan commitments, where monetary policy is characterized by a supply curve for reserves on the part of the central bank in an inter-bank market. If demand uncertainty relates primarily to the intensity of demand by each borrower with no difference in the degree of cyclicality of individual borrowers' demands, an inelastic supply of reserves by the central bank is optimal, because it stabilizes aggregate demand and as a result increases average capacity utilization. But if demand uncertainty relates primarily to the number of borrowers rather than to each one's demand for credit, an interest-rate smoothing policy is optimal, because it eliminates inefficient rationing of credit in high-demand states.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5660.

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Date of creation: Jul 1996
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Publication status: published as Journal of Monetary Economics, Vol. 37, no. 3 (June 1996): 573-605
Handle: RePEc:nbr:nberwo:5660

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  6. Goodfriend, Marvin, 1991. "Interest rates and the conduct of monetary policy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 34(1), pages 7-30, January.
  7. Fuerst, Timothy S., 1992. "Liquidity, loanable funds, and real activity," Journal of Monetary Economics, Elsevier, vol. 29(1), pages 3-24, February.
  8. Diamond,Peter A., 2009. "On Time," Cambridge Books, Cambridge University Press, number 9780521119764, 9.
  9. Donald P. Morgan, 1992. "Bank loan commitments and the lending view of monetary policy," Research Working Paper, Federal Reserve Bank of Kansas City 92-09, Federal Reserve Bank of Kansas City.
  10. Ben S. Bernanke & Mark Gertler, 1995. "Inside the Black Box: The Credit Channel of Monetary Policy Transmission," NBER Working Papers 5146, National Bureau of Economic Research, Inc.
  11. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
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  16. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
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Cited by:
  1. Marcelle Chauvet & Insu Kim, 2010. "Microfoundations of inflation persistence in the New Keynesian Phillips curve," CQER Working Paper 2010-05, Federal Reserve Bank of Atlanta.
  2. Eden, Benjamin, 1993. "Inflation and Price Adjustment: An Analysis of Micro Data," Working Papers, University of Iowa, Department of Economics 94-13, University of Iowa, Department of Economics, revised 1994.
  3. Woon Gyu Choi & Yungsan Kim, 2001. "Monetary Policy and Corporate Liquid Asset Demand," IMF Working Papers 01/177, International Monetary Fund.
  4. José Manuel Gutiérrez, 2001. "Money in Consumption Economies," Vienna Economics Papers, University of Vienna, Department of Economics 0105, University of Vienna, Department of Economics.
  5. Eyal Baharad & Benjamin Eden, 2004. "Price Rigidity and Price Dispersion: Evidence from Micro Data," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 7(3), pages 613-641, July.
  6. Bental, Benjamin & Eden, Benjamin, 2002. "Reserve requirements and output fluctuations," Journal of Monetary Economics, Elsevier, vol. 49(8), pages 1597-1620, November.
  7. Benjamin Eden, 2001. "Inventories and the Business Cycle: Testing a Sequential Trading Model," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 4(3), pages 562-574, July.
  8. Smith, R. Todd & van Egteren, Henry, 2005. "Interest rate smoothing and financial stability," Review of Financial Economics, Elsevier, vol. 14(2), pages 147-171.

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