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Loan Commitments and Optimal Monetary Policy

  • Michael Woodford

With loan commitments negotiated in advance, the use of tight money to restrain nominal spending has asymmetric effects upon different categories of borrowers. This can reduce efficiency, even though aggregate demand is stabilized. This is illustrated in the context of an equilibrium model of financial intermediation with loan commitments, where monetary policy is characterized by a supply curve for reserves on the part of the central bank in an inter-bank market. If demand uncertainty relates primarily to the intensity of demand by each borrower with no difference in the degree of cyclicality of individual borrowers' demands, an inelastic supply of reserves by the central bank is optimal, because it stabilizes aggregate demand and as a result increases average capacity utilization. But if demand uncertainty relates primarily to the number of borrowers rather than to each one's demand for credit, an interest-rate smoothing policy is optimal, because it eliminates inefficient rationing of credit in high-demand states.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5660.

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Date of creation: Jul 1996
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Publication status: published as Journal of Monetary Economics, Vol. 37, no. 3 (June 1996): 573-605
Handle: RePEc:nbr:nberwo:5660
Note: ME
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  1. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
  2. Lucas, Robert Jr., 1990. "Liquidity and interest rates," Journal of Economic Theory, Elsevier, vol. 50(2), pages 237-264, April.
  3. Fuerst, Timothy S., 1992. "Liquidity, loanable funds, and real activity," Journal of Monetary Economics, Elsevier, vol. 29(1), pages 3-24, February.
  4. Goodfriend, Marvin, 1991. "Interest rates and the conduct of monetary policy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 34(1), pages 7-30, January.
  5. Albert M. Wojnilower, 1980. "The Central Role of Credit Crunches in Recent Financial History," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 11(2), pages 277-340.
  6. Ben S. Bernanke & Mark Gertler, 1995. "Inside the Black Box: The Credit Channel of Monetary Policy Transmission," NBER Working Papers 5146, National Bureau of Economic Research, Inc.
  7. William Poole, 1969. "Optimal choice of monetary policy instruments in a simple stochastic macro model," Special Studies Papers 2, Board of Governors of the Federal Reserve System (U.S.).
  8. Meltzer, Allan & Goodhart, C.A.E., 2005. "A History Of The Federal Reserve," Macroeconomic Dynamics, Cambridge University Press, vol. 9(02), pages 267-275, April.
  9. Richard Clarida & Mark Gertler, 1996. "How the Bundesbank Conducts Monetary Policy," NBER Working Papers 5581, National Bureau of Economic Research, Inc.
  10. Eden, Benjamin, 1994. "The Adjustment of Prices to Monetary Shocks When Trade Is Uncertain and Sequential," Journal of Political Economy, University of Chicago Press, vol. 102(3), pages 493-509, June.
  11. Prescott, Edward C, 1975. "Efficiency of the Natural Rate," Journal of Political Economy, University of Chicago Press, vol. 83(6), pages 1229-36, December.
  12. Donald P. Morgan, 1992. "Bank loan commitments and the lending view of monetary policy," Research Working Paper 92-09, Federal Reserve Bank of Kansas City.
  13. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
  14. repec:cup:cbooks:9780521462891 is not listed on IDEAS
  15. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
  16. Dennis W. Carlton, 1991. "The Theory of Allocation and Its Implications for Marketing and Industrial Structure," NBER Working Papers 3786, National Bureau of Economic Research, Inc.
  17. Miron, Jeffrey A, 1986. "Financial Panics, the Seasonality of the Nominal Interest Rate, and theFounding of the Fed," American Economic Review, American Economic Association, vol. 76(1), pages 125-40, March.
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