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Monetary Policy and the Financing of Firms

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  • Fiorella de Fiore
  • Pedro Teles
  • Oreste Tristani

Abstract

How should monetary policy respond to changes in financial conditions? In this paper we consider a simple model where firms are subject to idiosyncratic shocks which may force them to default on their debt. Firms’ assets and liabilities are denominated in nominal terms and predetermined when shocks occur. Monetary policy can therefore affect the real value of funds used to finance production. Furthermore, policy affects the loan and deposit rates. We find that maintaining price stability at all times is not optimal; that the optimal response to adverse financial shocks is to lower interest rates, if not at the zero bound, and engineer a short period of inflation; that the Taylor rule may implement allocations that have opposite cyclical properties to the optimal ones.

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Paper provided by Banco de Portugal, Economics and Research Department in its series Working Papers with number w200917.

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Date of creation: 2009
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Handle: RePEc:ptu:wpaper:w200917

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References

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  1. Vasco Cúrdia & Michael Woodford, 2008. "Credit frictions and optimal monetary policy," Working Paper Research, National Bank of Belgium 146, National Bank of Belgium.
  2. Andrew T. Levin & Fabio M. Natalucci, 2005. "The Magnitude and Cyclical Behavior of Financial Market Frictions," 2005 Meeting Papers 443, Society for Economic Dynamics.
  3. Timothy S. Fuerst & Charles T. Carlstrom, 1998. "Agency costs and business cycles," Economic Theory, Springer, Springer, vol. 12(3), pages 583-597.
  4. Ben Bernanke & Mark Gertler & Simon Gilchrist, 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," NBER Working Papers 6455, National Bureau of Economic Research, Inc.
  5. Carlstrom, Charles T & Fuerst, Timothy S, 1997. "Agency Costs, Net Worth, and Business Fluctuations: A Computable General Equilibrium Analysis," American Economic Review, American Economic Association, vol. 87(5), pages 893-910, December.
  6. Timothy Fuerst & Matthias Paustian & Charles Carlstorm, 2009. "Optimal monetary policy in a model with agency costs," 2009 Meeting Papers, Society for Economic Dynamics 667, Society for Economic Dynamics.
  7. Gilchrist, Simon & Leahy, John V., 2002. "Monetary policy and asset prices," Journal of Monetary Economics, Elsevier, Elsevier, vol. 49(1), pages 75-97, January.
  8. Ester Faia, 2008. "Optimal Monetary Policy with Credit Augmented Liquidity Cycles," 2008 Meeting Papers 414, Society for Economic Dynamics.
  9. De Fiore, Fiorella & Tristani, Oreste, 2009. "Optimal monetary policy in a model of the credit channel," Working Paper Series, European Central Bank 1043, European Central Bank.
  10. Carlstrom, Charles T. & Fuerst, Timothy S., 2001. "Monetary shocks, agency costs, and business cycles," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 54(1), pages 1-27, June.
  11. Christiano, Lawrence & Motto, Roberto & Rostagno, Massimo, 2004. "The Great Depression and the Friedman-Schwartz hypothesis," Working Paper Series, European Central Bank 0326, European Central Bank.
  12. Ravenna, Federico & Walsh, Carl E., 2006. "Optimal monetary policy with the cost channel," Journal of Monetary Economics, Elsevier, Elsevier, vol. 53(2), pages 199-216, March.
  13. Ester Faia & Tommaso Monacelli, 2005. "Optimal Monetary Policy Rules, Asset Prices and Credit Frictions," Working Papers 279, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
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Cited by:
  1. Eleni Iliopulos & Thepthida Sopraseuth, 2012. "L’intermédiation financière dans l’analyse macroéconomique : Le défi de la crise," TEPP Research Report, TEPP 2012-02, TEPP.
  2. Filippo Occhino & Andrea Pescatori, 2012. "Leverage, investment, and optimal monetary policy," Working Paper 1238, Federal Reserve Bank of Cleveland.
  3. George A. Waters, 2011. "Quantity Rationing of Credit and the Phillips Curve," Working Paper Series 20111004, Illinois State University, Department of Economics.
  4. Isabel Marques Gameiro & Carla Soares & João Sousa, 2011. "Monetary policy and financial stability: an open debate," Economic Bulletin and Financial Stability Report Articles, Banco de Portugal, Economics and Research Department.
  5. Pedro Teles & Oreste Tristani & Fiorella De Fiore & Isabel Correia, 2013. "Credit Spreads and the Zero Bound on Interest Rates," 2013 Meeting Papers, Society for Economic Dynamics 1124, Society for Economic Dynamics.

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