Credit and the natural rate of interest

Fiorella De Fiore () and Oreste Tristani ()

No 889, Working Paper Series from European Central Bank

Abstract: We analyze the of the natural rate of interest in an economy where nominal debt contracts generate a spread between loan rates and the policy interest rate. In our model, monetary policy has real effects in the flexible-price equilibrium, because it affects the credit spread. Relying on a definition suitable for this environment, we demonstrate that: (i) the natural rate is independent of monetary policy and (ii) it delivers price stability, if used as the intercept of a monetary policy rule. The second result hold exactly if real balances are remunerated at a constand spread below policy interest rates, approximately otherwise. We also highlight, however, that the natural rate is not robust to model uncertainty. The natural rate reacts differently to aggregate shocks - not only quantitatively but also qualitatively - depending on the underlying model assumptions (e.g. whether or not financial markets are frictionless). JEL Classification: E40, E50, G10.

Keywords: Monetary policy; natural rate of interest; credit frictions. (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
Date: Written 2008-04
View list of references

Downloads: (external link)
http://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp889.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Persistent link: http://EconPapers.repec.org/RePEc:ecb:ecbwps:20080889

Ordering information: This working paper can be ordered from
Press and Information Division, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany

Access Statistics for this paper

More papers in Working Paper Series from European Central Bank
Address: Postfach 16 03 19, Frankfurt am Main, Germany
Contact information at EDIRC.
Series data maintained by Official Publications ().