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Optimal Monetary Policy in a Model with Agency Costs

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  • CHARLES T. CARLSTROM
  • TIMOTHY S. FUERST
  • MATTHIAS PAUSTIAN

Abstract

This paper integrates a fully explicit model of agency costs into an otherwise standard Dynamic New Keynesian model in a particularly transparent way. A principal result is the characterization of agency costs as endogenous markup shocks in an output‐gap version of the Phillips curve. The model's utility‐based welfare criterion is derived explicitly and includes a measure of credit market tightness that we interpret as a risk premium. The paper also fully characterizes optimal monetary policy and provides conditions under which zero inflation is the optimal policy. Finally, optimal policy can be expressed as an inflation targeting criterion that (depending upon parameter values) can be either forward or backward looking.

Suggested Citation

  • Charles T. Carlstrom & Timothy S. Fuerst & Matthias Paustian, 2010. "Optimal Monetary Policy in a Model with Agency Costs," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(s1), pages 37-70, September.
    • Handle: RePEc:wly:jmoncb:v:42:y:2010:i:s1:p:37-70
    DOI: 10.1111/j.1538-4616.2010.00329.x
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