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Credit and the Natural Rate of Interest

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  • FIORELLA DE FIORE
  • ORESTE TRISTANI

Abstract

We analyze the properties of the natural rate of interest in an economy where nominal debt contracts generate a spread between loan rates and the policy interest rate. In our model, monetary policy has real effects in the flexible-price equilibrium, because it affects the credit spread. Relying on a definition suitable for this environment, we demonstrate that: (i) the natural rate is independent of monetary policy and (ii) it delivers price stability, if used as the intercept of a monetary policy rule. The second result holds exactly if real balances are remunerated at a constant spread below policy interest rates, approximately otherwise. We also highlight, however, that the natural rate is not robust to model un-certainty. The natural rate reacts differently to aggregate shocks - not only quantitatively but also qualitatively - depending on the underlying model assumptions (e.g. whether or not financial markets are frictionless). JEL Classification: E40, E50, G10
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Suggested Citation

  • Fiorella De Fiore & Oreste Tristani, 2011. "Credit and the Natural Rate of Interest," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43, pages 407-440, March.
  • Handle: RePEc:mcb:jmoncb:v:43:y:2011:i::p:407-440
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    References listed on IDEAS

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    1. Bernanke, Ben S. & Gertler, Mark & Gilchrist, Simon, 1999. "The financial accelerator in a quantitative business cycle framework," Handbook of Macroeconomics,in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 21, pages 1341-1393 Elsevier.
    2. Marvin J. Barth III & Valerie A. Ramey, 2002. "The Cost Channel of Monetary Transmission," NBER Chapters,in: NBER Macroeconomics Annual 2001, Volume 16, pages 199-256 National Bureau of Economic Research, Inc.
    3. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2005. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 113(1), pages 1-45, February.
    4. (Kim | Lopez-Salido | Swanson) & Andrew Levin, 2004. "The magnitude and Cyclical Behavior of Financial Market Frictions," Computing in Economics and Finance 2004 224, Society for Computational Economics.
    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. Queijo, Virginia, 2005. "How Important are Financial Frictions in the U.S. and Euro Area?," Seminar Papers 738, Stockholm University, Institute for International Economic Studies.
    7. Timothy S. Fuerst & Charles T. Carlstrom, 1998. "Agency costs and business cycles," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 12(3), pages 583-597.
    8. 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.
    9. Douglas Gale & Martin Hellwig, 1985. "Incentive-Compatible Debt Contracts: The One-Period Problem," Review of Economic Studies, Oxford University Press, vol. 52(4), pages 647-663.
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    Cited by:

    1. Cúrdia, Vasco & Woodford, Michael, 2016. "Credit Frictions and Optimal Monetary Policy," Journal of Monetary Economics, Elsevier, vol. 84(C), pages 30-65.
    2. repec:bis:bisbps:95 is not listed on IDEAS
    3. Fiorella De Fiore & Oreste Tristani, 2013. "Optimal Monetary Policy in a Model of the Credit Channel," Economic Journal, Royal Economic Society, vol. 123(571), pages 906-931, September.
    4. Olmos, Lorena & Sanso Frago, Marcos, 2014. "Natural Rate of Interest with Endogenous Growth, Financial Frictions and Trend Inflation," MPRA Paper 57212, University Library of Munich, Germany.
    5. Peter McAdam, 2011. "Technology, hours and factor substitution," Research Bulletin, European Central Bank, vol. 13, pages 8-12.
    6. Choi, Woon Gyu & Cook, David, 2012. "Fire sales and the financial accelerator," Journal of Monetary Economics, Elsevier, vol. 59(4), pages 336-351.
    7. Romain Bouis & Łukasz Rawdanowicz & Jean-Paul Renne & Shingo Watanabe & Ane Kathrine Christensen, 2013. "The Effectiveness of Monetary Policy since the Onset of the Financial Crisis," OECD Economics Department Working Papers 1081, OECD Publishing.
    8. Jan Willem van den End & Marco Hoeberichts, 2014. "Low real rates as driver of secular stagnation: empirical assessment," DNB Working Papers 444, Netherlands Central Bank, Research Department.
    9. Martin Komrska, 2015. "Rakouská teorie hospodářského cyklu: VAR analýza pro USA v letech 1978-2013
      [The Austrian Business Cycle Theory: VAR Analysis for USA between 1978-2013]
      ," Politická ekonomie, University of Economics, Prague, vol. 2015(1), pages 57-73.
    10. Otmar Issing, 2009. "In search of monetary stability: the evolution of monetary policy," BIS Working Papers 273, Bank for International Settlements.
    11. Kobayashi, Teruyoshi, 2009. "Firm entry and monetary policy transmission under credit rationing," MPRA Paper 17553, University Library of Munich, Germany.
    12. Bratsiotis, George J., 2018. "Credit Risk, Excess Reserves and Monetary Policy: The Deposits Channel," EconStor Preprints 172770, ZBW - German National Library of Economics.
    13. repec:eee:japwor:v:46:y:2018:i:c:p:29-40 is not listed on IDEAS
    14. Feng Zhu, 2016. "A spectral perspective on natural interest rates in Asia-Pacific: changes and possible drivers," BIS Papers chapters,in: Bank for International Settlements (ed.), Expanding the boundaries of monetary policy in Asia and the Pacific, volume 88, pages 63-149 Bank for International Settlements.
    15. Claudio Borio & Piti Disyatat, 2011. "Global imbalances and the financial crisis: Link or no link?," BIS Working Papers 346, Bank for International Settlements.
    16. Luca Dedola, 2011. "Managing exchange rate misalignment and current account imbalances," Research Bulletin, European Central Bank, vol. 13, pages 2-7.
    17. International Monetary Fund, 2011. "Republic of Korea; Selected Issues," IMF Staff Country Reports 11/247, International Monetary Fund.
    18. Bhattarai, Saroj & Lee, Jae Won & Park, Woong Yong, 2015. "Optimal monetary policy in a currency union with interest rate spreads," Journal of International Economics, Elsevier, vol. 96(2), pages 375-397.
    19. George J. Bratsiotis, 2018. "Credit Risk, Excess Reserves and Monetary Policy: The Deposits," Centre for Growth and Business Cycle Research Discussion Paper Series 236, Economics, The Univeristy of Manchester.

    More about this item

    JEL classification:

    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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