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A Dynamic General Equilibrium Analysis of Monetary Policy Rules, Adverse Selection and Long-Run Financial Risk

  • Blommestein, Hans J.
  • Eijffinger, Sylvester C W
  • Qian, Zongxin

This paper builds a dynamic general equilibrium macro-finance model with two types of borrowers: entrepreneurs who want to produce and gamblers who want to play a lottery. It links central bank's interest rate policy to expected cash flows of both types. This link enables us to study how the interactions between various shocks and different monetary policy rules affect the borrower pool faced by financial intermediaries. We find that when the economy is hit by an expansionary monetary policy shock, the proportion of entrepreneurs in the borrower pool will be persistently lower than the steady state level after a short period. It is lowest when the central bank does not react to output fluctuations. Quite differently, not reacting to output fluctuations avoids a persistent worsening of the borrower pool in the long run if the shock is a bad productivity shock.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8652.

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Date of creation: Nov 2011
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Handle: RePEc:cpr:ceprdp:8652
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  1. Andrew B. Bernard & Jonathan Eaton & J. Bradford Jenson & Samuel Kortum, 2000. "Plants and Productivity in International Trade," NBER Working Papers 7688, National Bureau of Economic Research, Inc.
  2. Chowdhury, Ibrahim & Hoffmann, Mathias & Schabert, Andreas, 2004. "Inflation dynamics and the cost channel of monetary transmission," CFR Working Papers 04-01, University of Cologne, Centre for Financial Research (CFR).
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  9. Marvin Goodfriend & Bennett T. McCallum, 2007. "Banking and Interest Rates in Monetary Policy Analysis: A Quantitative Exploration," NBER Working Papers 13207, National Bureau of Economic Research, Inc.
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  12. Sander, Harald & Kleimeier, Stefanie, 2004. "Convergence in euro-zone retail banking? What interest rate pass-through tells us about monetary policy transmission, competition and integration," Journal of International Money and Finance, Elsevier, vol. 23(3), pages 461-492, April.
  13. Florin O. Bilbiie & Fabio Ghironi & Marc J. Melitz, 2008. "Monetary Policy and Business Cycles with Endogenous Entry and Product Variety," NBER Chapters, in: NBER Macroeconomics Annual 2007, Volume 22, pages 299-353 National Bureau of Economic Research, Inc.
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  19. Katharine Neiss & Edward Nelson, 2002. "Inflation dynamics, marginal cost, and the output gap: evidence from three countries," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
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