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Monetary Policy and the Financing of Firms

  • Fiorella de Fiore
  • Pedro Teles
  • Oreste Tristani

How should monetary policy respond to changes in financial conditions? In this paper we consider a simple model where firms are subject to idiosyncratic shocks which may force them to default on their debt. Firms’ assets and liabilities are denominated in nominal terms and predetermined when shocks occur. Monetary policy can therefore affect the real value of funds used to finance production. Furthermore, policy affects the loan and deposit rates. We find that maintaining price stability at all times is not optimal; that the optimal response to adverse financial shocks is to lower interest rates, if not at the zero bound, and engineer a short period of inflation; that the Taylor rule may implement allocations that have opposite cyclical properties to the optimal ones.

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Paper provided by Banco de Portugal, Economics and Research Department in its series Working Papers with number w200917.

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Date of creation: 2009
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Handle: RePEc:ptu:wpaper:w200917
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  1. (Kim | Lopez-Salido | Swanson) & Andrew Levin, 2004. "The magnitude and Cyclical Behavior of Financial Market Frictions," Computing in Economics and Finance 2004 224, Society for Computational Economics.
  2. Lawrence J. Christiano & Roberto Motto & Massimo Rostagno, 2003. "The Great Depression and the Friedman-Schwartz hypothesis," Proceedings, Federal Reserve Bank of Cleveland, pages 1119-1215.
  3. Ester Faia, 2008. "Optimal Monetary Policy with Credit Augmented Liquidity Cycles," 2008 Meeting Papers 414, Society for Economic Dynamics.
  4. De Fiore, Fiorella & Tristani, Oreste, 2009. "Optimal monetary policy in a model of the credit channel," Working Paper Series 1043, European Central Bank.
  5. Charles T. Carlstrom & Timothy S. Fuerst, 2000. "Monetary shocks, agency costs, and business cycles," Working Paper 0011, Federal Reserve Bank of Cleveland.
  6. Charles T. Carlstrom & Timothy S. Fuerst & Matthias Paustian, 2010. "Optimal Monetary Policy in a Model with Agency Costs," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(s1), pages 37-70, 09.
  7. Vasco Cúrdia & Michael Woodford, 2008. "Credit frictions and optimal monetary policy," Working Paper Research 146, National Bank of Belgium.
  8. Ben Bernanke & Mark Gertler & Simon Gilchrist, 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," NBER Working Papers 6455, National Bureau of Economic Research, Inc.
  9. Carlstrom, Charles T & Fuerst, Timothy S, 1997. "Agency Costs, Net Worth, and Business Fluctuations: A Computable General Equilibrium Analysis," American Economic Review, American Economic Association, vol. 87(5), pages 893-910, December.
  10. Ravenna, Federico & Walsh, Carl E., 2006. "Optimal monetary policy with the cost channel," Journal of Monetary Economics, Elsevier, vol. 53(2), pages 199-216, March.
  11. Faia, Ester & Monacelli, Tommaso, 2005. "Optimal Monetary Policy Rules, Asset Prices and Credit Frictions," CEPR Discussion Papers 4880, C.E.P.R. Discussion Papers.
  12. Timothy S. Fuerst & Charles T. Carlstrom, 1998. "Agency costs and business cycles," Economic Theory, Springer, vol. 12(3), pages 583-597.
  13. Gilchrist, Simon & Leahy, John V., 2002. "Monetary policy and asset prices," Journal of Monetary Economics, Elsevier, vol. 49(1), pages 75-97, January.
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