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The lending channel under optimal choice of monetary policy

Building on Cecchetti and Li (2005), we show that the bank lending channel affects monetary policy trade-offs only when interest rates affect marginal costs of production (ie when there is a cost channel of monetary policy) in the New Keynesian monetary policy model. In our calibrated model the resulting impact of the bank lending channel on output-inflation trade-offs is quantitatively small and of ambiguous sign. When bank capital varies counter cyclically and bank loan rates have a relatively large impact on marginal costs, variation of bank loan margins improves monetary policy trade-offs. The new Basel accord, by increasing capital requirements during economic downturns, offsets this beneficial impact.

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Paper provided by Bank of Finland in its series Research Discussion Papers with number 33/2007.

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Length: 39 pages
Date of creation: 15 Dec 2007
Date of revision:
Handle: RePEc:hhs:bofrdp:2007_033
Contact details of provider: Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
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