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Optimal Monetary Policy under Imperfect Financial Integration

  • Nao Sudo

    (Institute for Monetary and Economic Studies, Bank of Japan (E-mail: nao.sudo @boj.or.jp))

  • Yuki Teranishi

    (Associate Director, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: yuuki.teranishi @boj.or.jp))

After empirically showing imperfect financial integration among the euro countries, i.e., bank loan market heterogeneities in stickinesses of loan interest rates and markups from policy interest rate to loan rates, we build a New Keynesian model where such elements of imperfect financial integration coexist within a single currency area. Our welfare analysis reveals characteristics of optimal monetary policy. A central bank should take these heterogeneities into consideration. The optimal monetary policy is tied to difference in the degree of loan rate stickiness, the size of the steady-state loan rate markup, and the share of the loan market. By calibrating our model to the euro, we present the raking of the euro countries in terms of monetary policy priority. Because of the heterogeneity in the loan markets among the euro area countries, this ordering is not equivalent to the size of the financial market.

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Paper provided by Institute for Monetary and Economic Studies, Bank of Japan in its series IMES Discussion Paper Series with number 08-E-25.

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Date of creation: Dec 2008
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Handle: RePEc:ime:imedps:08-e-25
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