Credit Market Distortions, Asset Prices and Monetary Policy

D. Pfajfar, E. Santoro

Research output: Working paperDiscussion paperOther research output

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Abstract

Abstract: We study the conditions that ensure rational expectations equilibrium (REE) determinacy and expectational stability (E-stability) in a standard sticky-price model augmented with the cost channel. We allow for varying degrees of pass-through of the policy rate to bank-lending rates. Strong cost-side effects heavily constrain the policy rate response to inflation from above, so that inflation tar- geting policies may not be capable of ensuring REE uniqueness. In such cases, it is advisable to combine inflation responses with an appropriate reaction to the output gap and/or firm profitability. The negative reaction of real activity and asset prices to inflationary shocks adds a negative force to inflation responses that counteracts the borrowing cost effect and avoids expectations of higher inflation to become self-fulfilling.
Original languageEnglish
Place of PublicationTilburg
PublisherEconomics
Number of pages28
Volume2012-010
Publication statusPublished - 2012

Publication series

NameCentER Discussion Paper
Volume2012-010

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Credit markets
Price policy
Asset prices
Inflation
Monetary policy
Rational expectations equilibrium
Costs
Bank lending
Cost channel
Real activity
Expectational stability
Sticky prices
Borrowing
Pass-through
Side effects
Inflation targeting
Output gap
Equilibrium determinacy
Firm profitability
High inflation

Keywords

  • Monetary Policy
  • Cost Channel
  • Asset Prices
  • Determinacy
  • E-stability

Cite this

Pfajfar, D., & Santoro, E. (2012). Credit Market Distortions, Asset Prices and Monetary Policy. (CentER Discussion Paper; Vol. 2012-010). Tilburg: Economics.
Pfajfar, D. ; Santoro, E. / Credit Market Distortions, Asset Prices and Monetary Policy. Tilburg : Economics, 2012. (CentER Discussion Paper).
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Pfajfar, D & Santoro, E 2012 'Credit Market Distortions, Asset Prices and Monetary Policy' CentER Discussion Paper, vol. 2012-010, Economics, Tilburg.

Credit Market Distortions, Asset Prices and Monetary Policy. / Pfajfar, D.; Santoro, E.

Tilburg : Economics, 2012. (CentER Discussion Paper; Vol. 2012-010).

Research output: Working paperDiscussion paperOther research output

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AB - Abstract: We study the conditions that ensure rational expectations equilibrium (REE) determinacy and expectational stability (E-stability) in a standard sticky-price model augmented with the cost channel. We allow for varying degrees of pass-through of the policy rate to bank-lending rates. Strong cost-side effects heavily constrain the policy rate response to inflation from above, so that inflation tar- geting policies may not be capable of ensuring REE uniqueness. In such cases, it is advisable to combine inflation responses with an appropriate reaction to the output gap and/or firm profitability. The negative reaction of real activity and asset prices to inflationary shocks adds a negative force to inflation responses that counteracts the borrowing cost effect and avoids expectations of higher inflation to become self-fulfilling.

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Pfajfar D, Santoro E. Credit Market Distortions, Asset Prices and Monetary Policy. Tilburg: Economics. 2012. (CentER Discussion Paper).