Credit Market Distortions, Asset Prices and Monetary Policy

D. Pfajfar, E. Santoro

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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 passthrough 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 e¤ect and avoids expectations of higher inflation to become self-fulfilling.
Original languageEnglish
Place of PublicationTilburg
PublisherEBC
Number of pages28
Volume2012-005
Publication statusPublished - 2012

Publication series

NameEBC Discussion Paper
Volume2012-005

Keywords

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

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