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Welfare effect of interest rate shocks and policy implications

  • Richard E. Ericson
  • Xuan Liu
Registered author(s):

    This article studies the welfare effect of exogenous country spread shocks and policy implications. First, country spread shocks are welfare-improving, a finding holding for three widely used preference representations over a wide range of structural parameter values, both in a two-period model with fixed endowments and in a workhorse Dynamic Stochastic General Equilibrium (DSGE) model of a small open economy. Second, it is always optimal to have procyclical policy unless (i) financial frictions are strong, (ii) policy responds to country spread gaps, and (iii) the subjective discount factor is endogenous.

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    File URL: http://hdl.handle.net/10.1080/09603107.2012.688939
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    Article provided by Taylor & Francis Journals in its journal Applied Financial Economics.

    Volume (Year): 22 (2012)
    Issue (Month): 22 (November)
    Pages: 1899-1917

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    Handle: RePEc:taf:apfiec:v:22:y:2012:i:22:p:1899-1917
    DOI: 10.1080/09603107.2012.688939
    Contact details of provider: Web page: http://www.tandfonline.com/RAFE20

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