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Imperfect credit markets: implications for monetary policy

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Author Info
Vlieghe, Gertjan W

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Abstract

I develop a model for monetary policy analysis that features significant feedback from asset prices to macroeconomic quantities. The feedback is caused by credit market imperfections, which dynamically affect how efficiently labour and capital are being used in aggregate. I then analyse what implications this mechanism has for monetary policy. The paper offers three insights. First, the monetary transmission mechanism works not only via nominal rigidites but also via a reallocation of productive resources away from the most productive agents. Second, following an adverse productivity shock there is a dynamic trade-off between the immediate fall in output, which is an effcient response to the productivity fall, and the fall in output thereafter, which is caused by a reallocation of resources away from the most productive agents. The more the initial output fall is dampened with a temporary rise in inflation, the more the adverse future effects of the reallocation of resources are mitigated. Third, in a full welfare-based analysis of optimal monetary policy I show that it is optimal to have some inflation variability, even if the only shocks in the economy are productivity shocks. The optimal variability of inflation is small, but the costs of stabilising inflation too aggressively can be large.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 12957.

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Date of creation: 20 Mar 2007
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Handle: RePEc:pra:mprapa:12957

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Related research
Keywords: monetary policy; credit frictions; credit crunch; optimal monetary policy;

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Find related papers by JEL classification:
E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles

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