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Optimal Monetary Policy in a Sudden Stop

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  • Braggion, F.

    (Tilburg University)

  • Christiano, L.
  • Roldos, J.

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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Bibliographic Info

Paper provided by Tilburg University in its series Open Access publications from Tilburg University with number urn:nbn:nl:ui:12-3107633.

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Length: 49
Date of creation: 2007
Date of revision:
Handle: RePEc:ner:tilbur:urn:nbn:nl:ui:12-3107633

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Web page: http://www.tilburguniversity.edu/

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