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Monetary Policy and the Financing of Firms

  • Fiorella De Fiore
  • Pedro Teles
  • Oreste Tristani

How should monetary policy respond to changes in financial conditions? We consider a simple model where firms are subject to shocks which may force them to default on their debt. Firms' assets and liabilities are nominal and predetermined. Monetary policy can therefore affect the real value of funds used to finance production. In this model, allowing for inflation volatility in response to aggregate shocks can be optimal; the optimal response to adverse financial shocks is to lower interest rates and to engineer some inflation; and the Taylor rule may implement allocations that have opposite cyclical properties to the optimal ones. (JEL G32, E31, E43, E44, E52)

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File URL: http://www.aeaweb.org/articles.php?doi=10.1257/mac.3.4.112
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Article provided by American Economic Association in its journal American Economic Journal: Macroeconomics.

Volume (Year): 3 (2011)
Issue (Month): 4 (October)
Pages: 112-42

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Handle: RePEc:aea:aejmac:v:3:y:2011:i:4:p:112-42
Note: DOI: 10.1257/mac.3.4.112
Contact details of provider: Web page: https://www.aeaweb.org/aej-macro
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  1. 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.
  2. De Fiore, Fiorella & Tristani, Oreste, 2009. "Optimal monetary policy in a model of the credit channel," Working Paper Series 1043, European Central Bank.
  3. Lawrence J. Christiano & Roberto Motto & Massimo Rostagno, 2004. "The Great Depression and the Friedman-Schwartz hypothesis," Working Paper 0318, Federal Reserve Bank of Cleveland.
  4. Andrew T. Levin & Fabio M. Natalucci & Egon Zakrajsek, 2004. "The magnitude and cyclical behavior of financial market frictions," Finance and Economics Discussion Series 2004-70, Board of Governors of the Federal Reserve System (U.S.).
  5. Gilchrist, Simon & Leahy, John V., 2002. "Monetary policy and asset prices," Journal of Monetary Economics, Elsevier, vol. 49(1), pages 75-97, January.
  6. Timothy Fuerst & Matthias Paustian & Charles Carlstorm, 2009. "Optimal monetary policy in a model with agency costs," 2009 Meeting Papers 667, Society for Economic Dynamics.
  7. Timothy S. Fuerst & Charles T. Carlstrom, 1998. "Agency costs and business cycles," Economic Theory, Springer, vol. 12(3), pages 583-597.
  8. Bernanke, B. & Gertler, M. & Gilchrist, S., 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," Working Papers 98-03, C.V. Starr Center for Applied Economics, New York University.
  9. Vasco Cúrdia & Michael Woodford, 2009. "Credit frictions and optimal monetary policy," BIS Working Papers 278, Bank for International Settlements.
  10. Ester Faia, 2008. "Optimal Monetary Policy with Credit Augmented Liquidity Cycles," 2008 Meeting Papers 414, Society for Economic Dynamics.
  11. Ravenna, Federico & Walsh, Carl E., 2006. "Optimal monetary policy with the cost channel," Journal of Monetary Economics, Elsevier, vol. 53(2), pages 199-216, March.
  12. Carlstrom, Charles T. & Fuerst, Timothy S., 2001. "Monetary shocks, agency costs, and business cycles," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 54(1), pages 1-27, June.
  13. Faia, Ester & Monacelli, Tommaso, 2005. "Optimal Monetary Policy Rules, Asset Prices and Credit Frictions," CEPR Discussion Papers 4880, C.E.P.R. Discussion Papers.
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