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Banking and interest rates in monetary policy analysis: A quantitative exploration

  • Goodfriend, Marvin
  • McCallum, Bennett T.

The paper reconsiders the role of money and banking in monetary policy analysis by including a banking sector and money in an optimizing model otherwise of a standard type. The model is implemented quantitatively, with a calibration based on U.S. data. It is reasonably successful in providing an endogenous explanation for substantial steady-state differentials between the interbank policy rate and (i) the collateralized loan rate, (ii) the uncollateralized loan rate, (iii) the T-bill rate, (iv) the net marginal product of capital, and (v) a pure intertemporal rate. We find a differential of over 3 % pa between (iii) and (iv), thereby contributing to resolution of the equity premium puzzle. Dynamic impulse response functions imply pro-or-counter-cyclical movements in an external finance premium that can be of quantitative significance. In addition, they suggest that a central bank that fails to recognize the distinction between interbank and other short rates could miss its appropriate settings by as much as 4% pa. Also, shocks to banking productivity or collateral effectiveness call for large responses in the policy rate.

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Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 54 (2007)
Issue (Month): 5 (July)
Pages: 1480-1507

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Handle: RePEc:eee:moneco:v:54:y:2007:i:5:p:1480-1507
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505566

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  1. 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.
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  3. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
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  6. Douglas W. Diamond & Raghuram G. Rajan, 2003. "Money in a Theory of Banking," NBER Working Papers 10070, National Bureau of Economic Research, Inc.
  7. Kocherlakota, Narayana R, 1996. "Implications of Efficient Risk Sharing without Commitment," Review of Economic Studies, Wiley Blackwell, vol. 63(4), pages 595-609, October.
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  9. Peter N. Ireland, 2001. "Money's Role in the Monetary Business Cycle," NBER Working Papers 8115, National Bureau of Economic Research, Inc.
  10. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
  11. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
  12. Huggett, Mark, 1993. "The risk-free rate in heterogeneous-agent incomplete-insurance economies," Journal of Economic Dynamics and Control, Elsevier, vol. 17(5-6), pages 953-969.
  13. Anil K. Kashyap & Raghuram Rajan & Jeremy C. Stein, 1999. "Banks as Liquidity Providers: An Explanation for the Co-Existence of Lending and Deposit-Taking," NBER Working Papers 6962, National Bureau of Economic Research, Inc.
  14. John Y. Campbell, 1998. "Asset Prices, Consumption, and the Business Cycle," NBER Working Papers 6485, National Bureau of Economic Research, Inc.
  15. Allan H. Meltzer, 1995. "Monetary, Credit and (Other) Transmission Processes: A Monetarist Perspective," Journal of Economic Perspectives, American Economic Association, vol. 9(4), pages 49-72, Fall.
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  17. Charles T. Carlstrom & Timothy S. Fuerst, 1996. "Agency costs, net worth, and business fluctuations: a computable general equilibrium analysis," Working Paper 9602, Federal Reserve Bank of Cleveland.
  18. Bennett T. McCallum, 2001. "Monetary Policy Analysis in Models Without Money," NBER Working Papers 8174, National Bureau of Economic Research, Inc.
  19. Ben S. Bernanke & Mark Gertler, 1995. "Inside the Black Box: The Credit Channel of Monetary Policy Transmission," Journal of Economic Perspectives, American Economic Association, vol. 9(4), pages 27-48, Fall.
  20. Bansal, Ravi & Coleman, Wilbur John, II, 1996. "A Monetary Explanation of the Equity Premium, Term Premium, and Risk-Free Rate Puzzles," Journal of Political Economy, University of Chicago Press, vol. 104(6), pages 1135-71, December.
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  25. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
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