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Credit Market Distortions, Asset Prices and Monetary Policy

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  • Pfajfar, D.
  • Santoro, E.

Abstract

In this paper we develop a sticky price DSGE model to study the role of capital market imperfections for monetary policy implementation. Recent empirical and theoretical studies have stressed the e¤ect of .rms.external .nance on their pricing decisions. The so-called cost channel of the transmission mechanism has been explored within New Keynesian frameworks that pose particular emphasis on in.ation dynamics. These models generally disregard the role of external .nance for the dynamics of asset prices. We ask whether monetary policy should respond to deviations of asset prices from their frictionless level and, more importantly, if the answer to this question changes when financial frictions are properly taken into account. We analyze these issues from the vantage of equilibrium determinacy and stability under adaptive learning. We show that usual conditions for equilibrium uniqueness and E-stability are significantly altered when the cost channel matters. Nevertheless, we find that responding to actual or expected asset price misalignments helps at restoring determinacy and stability under learning. These conclusions are further enforced in the presence of a high degree of pass-through from policy to bank lending rates.

Suggested Citation

  • Pfajfar, D. & Santoro, E., 2008. "Credit Market Distortions, Asset Prices and Monetary Policy," Cambridge Working Papers in Economics 0825, Faculty of Economics, University of Cambridge.
  • Handle: RePEc:cam:camdae:0825
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    Cited by:

    1. Araújo, Eurilton, 2016. "Determinacy and learnability of equilibrium in a small-open economy with sticky wages and prices," International Review of Economics & Finance, Elsevier, vol. 45(C), pages 16-32.
    2. Tamborini, Roberto, 2009. "The "Credit-Cost Channel" of Monetary Policy. A Theoretical Assessment," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy (IfW), vol. 3, pages 1-23.
    3. Pfajfar, Damjan & Santoro, Emiliano, 2011. "Determinacy, stock market dynamics and monetary policy inertia," Economics Letters, Elsevier, vol. 112(1), pages 7-10, July.
    4. Tayler, William & Zilberman, Roy, 2014. "Macroprudential Regulation and the Role of Monetary Policy," Dynare Working Papers 37, CEPREMAP.
    5. George W. Evans & Seppo Honkapohja, 2009. "Expectations, Learning and Monetary Policy: An Overview of Recent Research," Central Banking, Analysis, and Economic Policies Book Series,in: Klaus Schmidt-Hebbel & Carl E. Walsh & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series (ed.), Monetary Policy under Uncertainty and Learning, edition 1, volume 13, chapter 2, pages 027-076 Central Bank of Chile.
    6. Pfajfar, D. & Zakelj, B., 2011. "Inflation Expectations and Monetary Policy Design : Evidence from the Laboratory (Replaces CentER DP 2009-007)," Discussion Paper 2011-091, Tilburg University, Center for Economic Research.
    7. Beck, Thorsten & Colciago, Andrea & Pfajfar, Damjan, 2014. "The role of financial intermediaries in monetary policy transmission," Journal of Economic Dynamics and Control, Elsevier, vol. 43(C), pages 1-11.
    8. Nkwoma, Inekwe John, 2017. "Futures-Based Measures Of Monetary Policy And Jump Risk," Macroeconomic Dynamics, Cambridge University Press, vol. 21(02), pages 384-405, March.
    9. Singh, Aarti & Stone, Sophie & Suda, Jacek, 2015. "Monetary policy and the financial sector," Economics Letters, Elsevier, vol. 132(C), pages 82-86.
    10. Best, Gabriela, 2015. "A New Keynesian model with staggered price and wage setting under learning," Journal of Economic Dynamics and Control, Elsevier, vol. 57(C), pages 96-111.
    11. Machado, Vicente da Gama, 2013. "Monetary policy rules, asset prices and adaptive learning," Journal of Financial Stability, Elsevier, vol. 9(3), pages 251-258.
    12. Roberta CARDANI, "undated". "Optimal Monetary Policy with Wealth Effect and Cost Channel," EcoMod2008 23800021, EcoMod.

    More about this item

    Keywords

    Monetary Policy; Capital Market Imperfections; Cost Channel; Asset Price.;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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