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Capital Injection, Monetary Policy, and Financial Accelerators

  • Naohisa Hirakata

    (Bank of Japan)

  • Nao Sudo

    (Bank of Japan)

  • Kozo Ueda

    (Waseda University)

We evaluate the implications of spread-adjusted Taylor rules and capital injection policies in response to adverse shocks to the economy, using a variant of the financial accelerator model. Our model comprises the two credit-constrained sectors that raise external finance under credit market imperfection: financial intermediaries (FIs) and entrepreneurs. With the model estimated using the U.S. data, we find that a spread-adjusted Taylor rule mitigates (amplifies) the impact of adverse shocks when the shock is accompanied by a widening (shrinking) of the corresponding spread. We formalize a capital injection policy as a positive (negative) amount of injection to either of the two sectors in response to an adverse shock (a favorable shock). In contrast to a spread-adjusted Taylor rule, a positive injection boosts the economy regardless of the type of shock. The capital injection to the FIs has a greater impact on the economy compared with that to the entrepreneurs. Our result shows support for adopting the spread-adjusted Taylor rules and capital injections, although welfare implication varies depending on the source of economic downturn and excessive responses aggravate welfare.

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Article provided by International Journal of Central Banking in its journal International Journal of Central Banking.

Volume (Year): 9 (2013)
Issue (Month): 2 (June)
Pages: 101-145

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Handle: RePEc:ijc:ijcjou:y:2013:q:2:a:6
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  1. Césaire Meh & Kevin Moran, 2008. "The Role of Bank Capital in the Propagation of Shocks," Working Papers 08-36, Bank of Canada.
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