Monetary Policy Rules, Adverse Selection and Long-Run Financial Risk

H.J. Blommestein, S.C.W. Eijffinger, Z. Qian

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Abstract

This paper constructs a macro-finance model with two types of borrowers: entrepreneurs who engage in productive activities and gamblers who play in lotteries. It links a central bank's interest rate policy to expected cash ows of both types of borrowers. Via this link we study how the interactions between various shocks and different monetary policy rules affect the quality of the borrower pool faced by financial intermediaries. We find that if the economy is hit by an expansionary monetary policy shock, in the long run the proportion of entrepreneurs in the borrower pool will be persistently lower than the steady state level. This worsening of the borrower pool is more serious if the central bank does not react to output uctuations. By contrast, not reacting to output uctuations in case of a negative productivity shock avoids a persistent worsening of the borrower pool in the long run.
Original languageEnglish
Place of PublicationTilburg
PublisherEBC
Number of pages58
Volume2011-032
Publication statusPublished - 2011

Publication series

NameEBC Discussion Paper
Volume2011-032

Keywords

  • Monetary Policy
  • Adverse Selection
  • Financial Crisis

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  • Cite this

    Blommestein, H. J., Eijffinger, S. C. W., & Qian, Z. (2011). Monetary Policy Rules, Adverse Selection and Long-Run Financial Risk. (EBC Discussion Paper; Vol. 2011-032). EBC.