Euler equations and monetary policy

Euler equations are the key link between monetary policy and the real economy in NK models. Under separable preferences, they fail to match interest rates. Non-separability between leisure and consumption significantly improves their fit and reliability for studying monetary policy.     

Cross-country differences in monetary policy execution and money market rates’ volatility

Volatility patterns in overnight interest rates display differences across industrial countries that existing models—designed to replicate the features of individual countries’ markets—cannot account for. This paper presents an equilibrium model of the overnight interbank market that matches cross-country differences in patterns in interest volatility by incorporating differences in how central banks manage liquidity in response to shocks. Our model is consistent with central banks’ practice of rationing access to marginal facilities when the objective of stabilizing short-term interest rates conflicts with another high-frequency objective, such as an exchange rate target.     

Credit spread and monetary policy

We show that the spread-adjusted Taylor rule including a response to the credit spread is a theoretically optimal monetary policy under heterogeneous loan contracts. However, the optimal response to the credit spread is ambiguous, given the financial market structure.     

Dichotomy between macroprudential policy and monetary policy on credit and inflation

This paper compares macroprudential policy and monetary policy using a simple New Keynesian model with credit. Macroprudential policy is effective in stabilizing credit with limited impact on inflation. Monetary policy stabilizes inflation, but is ‘too blunt’ for credit stabilization.     

Trade credit, bank lending and monetary policy transmission

This paper investigates the role of trade credit in the transmission of monetary policy. Most models of the transmission mechanism allow firms to access only financial markets or bank lending according to some net worth criterion. In our model we consider external finance from trade credit as an additional source of funding for firms that cannot obtain credit from banks. We predict that when monetary policy tightens there will be a reduction in bank lending relative to trade credit. This is confirmed with an empirical investigation of 16,000 UK manufacturing firms.     

Optimal fiscal and monetary policy under sticky prices

This paper studies optimal fiscal and monetary policy under sticky product prices. The theoretical framework is a stochastic production economy. The government finances an exogenous stream of purchases by levying distortionary income taxes, printing money, and issuing nominal non-state-contingent bonds. The main findings of the paper are: First, for a miniscule degree of price stickiness (i.e., many times below available empirical estimates) the optimal volatility of inflation is near zero. Second, small deviations from full price flexibility induce near random walk behavior in government debt and tax rates. Finally, price stickiness induces deviation from the Friedman rule.     

The role of financial sector competition for monetary policy

Abstract In this paper, we examine the impact of competition in the banking industry on financial market activity. In particular, we explore this issue in a setting where banks simultaneously insure individuals against liquidity risk and offer loans to promote intertemporal consumption smoothing. In addition, spatial separation and private information generate a transactions role for money. Interestingly, we demonstrate that the industrial organization of the financial system bears significant implications for the effects of monetary policy. Under perfect competition, higher rates of money growth lead to lower interest rates and a higher volume of lending activity. In contrast, in a monopoly banking sector, money growth restricts the availability of funds and raises the cost of borrowing.     

Collateral rehypothecation,safe asset scarcity,and unconventional monetary policy

We build a mark-to-market model where commercial banks can enlarge their balance sheets, repledging the available collateral several times to exchange liquidity through the interbank market. In bad times, the fall of risky asset price disrupts the length of the repledging chain due to the increase of the haircut and the decrease of external assets' value. In such a scenario, the central bank can intervene implementing unconventional monetary policies by purchasing a fraction of the banking system's external assets, both safe treasury bonds, and risky asset-backed securities, to inject liquidity. Our results show that a quantitative easing policy that purchases only safe assets is highly ineffective in restoring the intermediation activity to the pre-crisis level due to its inability to sustain the risky asset price and the repledging chain of collateral. Instead, focusing on risky assets only, the monetary authority can sustain risky asset prices, avoiding the freezing of the money market.     

Bond risk premiums and optimal monetary policy

The bond yield dynamics implied by a welfare-maximizing monetary policy and its credibility are explored in general equilibrium. Credibility is captured by a regime change from discretion to commitment. The policy determines the optimal output and inflation responses to a source of inflation risk. Bond yields contain compensations for this risk that depend on the policy. Credibility improvements reduce the exposure to inflation risk and bond risk premiums decline. A model calibration implies lower yield spreads, less volatile yields, and reduced deviations from the expectations hypothesis under commitment. The model suggests an explanation for changes in yield dynamics in the U.S. across different policy regimes.     

Financial market imperfections and monetary policy strategy

In a model with imperfect money, credit and reserve markets, we examine if an inflation-targeting central bank applying the funds rate operating procedure to indirectly control market interest rates also needs a monetary aggregate as policy instrument. We show that if private agents use information extracted from money and financial markets to form inflation expectations and if interest rate pass-through is incomplete, the central bank can use a narrow monetary aggregate and the discount interest rate as independent and complementary policy instruments to reinforce the credibility of its announcements and the role of inflation target as a nominal anchor for inflation expectations. This study shows how a monetary policy strategy combining inflation targeting and monetary targeting can be conceived to guarantee macroeconomic stability and the credibility of monetary policy. Friedman's k-percent money growth rule, which can generate dynamic instability, and two alternative stabilizing feedback monetary targeting rules are examined.     

Distortionary fiscal policy and monetary policy goals

We reconsider the role of an inflation conservative central banker in a setting with distortionary taxation. To do so, we assume monetary and fiscal policy are decided by independent authorities that do not abide to past commitments. If the two authorities make policy decisions simultaneously, inflation conservatism causes fiscal overspending. But if fiscal policy is determined before monetary policy, inflation conservatism imposes fiscal discipline. These results clarify that in our setting the value of inflation conservatism depends crucially on the timing of policy decisions.     

Household debt,macroprudential rules,and monetary policy

Today's Canadian economy features a historic high of household debt and persistently low growth rate. The average debt-to-GDP ratio has reached the level experienced in the U.S. just prior to the recent financial crisis. In this paper, we ask whether monetary policy should lean against the household indebtedness or macroprudential policies are better suited for the task. To provide a quantitative answer, we develop a small open economy dynamic stochastic general equilibrium model featuring a micro-founded banking sector. We estimate the model using Canadian data and conduct policy experiments. Our findings favor macroprudential approach to reining in indebtedness: using monetary policy that reacts to household debt increases inflation volatility and lowers borrowers' welfare, while using macroprudential policies such as lowering the loan-to-value ratio limit increases borrowers' welfare.     

Disinflation costs in China and monetary policy regimes

This paper investigates the real effects of a disinflationary policy in China, in which we conduct a disinflation experiment in a medium-scale New Keynesian model. We highlight two key features of China's economy: the relevance of money to monetary policy rules and household inequality. For the former, we consider two monetary policy regimes: an expanded Taylor rule with money and a money supply rule. For the latter, we take into account a share of the population that is limited in its ability to participate in assets markets. Our analysis suggests that a disinflation policy is more costly when the central bank controls the money supply than the case in which the nominal interest rate is the policy instrument. Our results are driven by the different impacts of disinflation on nominal and real interest rates under the two regimes.     

Rule-of-thumb behaviour and monetary policy

We investigate the implications of rule-of-thumb behaviour by consumers or price setters for optimal monetary policy and simple interest rate rules. This behaviour leads to endogenous persistence in output and inflation and alters the policymaker's welfare objective. Our main finding is that highly inertial policy is optimal regardless of what fraction of agents occasionally follow a rule of thumb. We also find that a first-difference version of Taylor's (Carnegie-Rochester Conf. Ser. Public Policy 39 (1993) 195-214) rule generally has desirable properties. By contrast, the coefficients in other optimised simple rules tend to be extremely sensitive with respect to the fraction of rule-of-thumb behaviour.     

Household's preferences and monetary policy inertia

Interest rates set by central banks puzzlingly move with a certain inertia. We show that household's preferences can be important determinants of the optimal interest rate inertia due to their impact on the efficiency of the monetary policy transmission mechanism.     

The financial accelerator and monetary policy rules

Comparing Bernanke et al.’s (1999) financial accelerator model to a comparable model without an operational financial accelerator mechanism, we find that financial acceleration is reduced when monetary policy reacts to the output gap and when firm-specific volatility rises.     

Do asymmetries matter for European monetary policy?

In this paper we analyze the impact of economic and institutional (ECB decision rules) asymmetries on the effectiveness of monetary policy in Euroland. We consider a model where asymmetric shocks and divergent propagation of shocks in output and inflation are potential causes of tensions within the ECB concerning the conduct of common monetary (interest rate) policy. Welfare implications of the alternative decision procedures are discussed.     

Transparency in monetary policy: A general equilibrium approach

We study a general equilibrium model with a central bank (CB) and two groups of agents, producers and workers. The CB maximizes a weighted average of utilities of the two groups. The CB has two possible types, one favoring workers and the other favoring producers. The CB's type is private information. We compare two possible monetary policy regimes, transparent and opaque. For realistic values of parameters, it is shown that workers are better off under the opaque regime, whereas producers are better off under the transparent regime. This result is shown to hold in two cases, when the range of possible monetary transfers is small and when the range of possible monetary transfers is large.     

Endogenous trading constraints with incomplete asset markets

This paper endogenizes the borrowing constraints on capital in a production economy with incomplete markets. We find that these limits get looser with income, a property that is consistent with US data on credit limits. The framework with endogenous limits is then used to study the effects of a revenue neutral tax reform that eliminates capital income taxes. Our results illustrate that it is very important to take into account the effects of tax policies on the limits. Throughout the transition, these effects can be big enough to change the overall conclusion about the desirability of a tax reform.