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Tight Money-Tight Credit: Coordination Failure in the Conduct of Monetary and Financial Policies

Author

Listed:
  • Julio A. Carrillo

    (Banco de México (E-mail: jcarrillo@banxico.org.mx))

  • Enrique G. Mendoza

    (University of Pennsylvania (E-mail: egme@sas.upenn.edu))

  • Victoria Nuguer

    (Inter-American Development Bank (E-mail: victorian@iadb.org))

  • Jessica Roldán-Peña

    (Banco de México (E-mail: jroldan@banxico.org.mx))

Abstract

Violations of Tinbergen's Rule and strategic interaction undermine monetary and financial policies significantly in a New Keynesian model with the Bernanke-Gertler accelerator. Welfare costs of risk shocks are large because of efficiency losses and income effects of costly monitoring, but they are larger under a simple Taylor rule (STR) and a Taylor rule augmented with credit spreads (ATR) than under a dual rules regime (DRR) with a Taylor rule and a financial rule targeting spreads, by 264 and 138 basis points respectively. ATR and STR are tight money-tight credit regimes that respond too much to inflation and not enough to spreads, and yield larger fluctuations in response to risk shocks. Reaction curves display shifts from strategic substitutes to complements in the choice of policy-rule elasticities. The Nash equilibrium is also a tight money-tight credit regime, with welfare 30 basis points lower than in Cooperative equilibria and the DRR, but still sharply higher than in the ATR and STR regimes.

Suggested Citation

  • Julio A. Carrillo & Enrique G. Mendoza & Victoria Nuguer & Jessica Roldán-Peña, 2019. "Tight Money-Tight Credit: Coordination Failure in the Conduct of Monetary and Financial Policies," IMES Discussion Paper Series 19-E-08, Institute for Monetary and Economic Studies, Bank of Japan.
    • Handle: RePEc:ime:imedps:19-e-08
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    References listed on IDEAS

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    Keywords

    Monetary policy; Financial frictions; Macroprudential policy; Leaning against the wind; Policy coordination;

    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

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