Credit Market Distortions, Asset Prices and Monetary Policy

Damjan Pfajfar and Emiliano Santoro

Cambridge Working Papers in Economics from Faculty of Economics, University of Cambridge

Abstract: In this paper we develop a sticky price DSGE model to study the role of capital market imperfections for monetary policy implementation. Recent empirical and theoretical studies have stressed the e¤ect of .rms.external .nance on their pricing decisions. The so-called cost channel of the transmission mechanism has been explored within New Keynesian frameworks that pose particular emphasis on in.ation dynamics. These models generally disregard the role of external .nance for the dynamics of asset prices. We ask whether monetary policy should respond to deviations of asset prices from their frictionless level and, more importantly, if the answer to this question changes when financial frictions are properly taken into account. We analyze these issues from the vantage of equilibrium determinacy and stability under adaptive learning. We show that usual conditions for equilibrium uniqueness and E-stability are significantly altered when the cost channel matters. Nevertheless, we find that responding to actual or expected asset price misalignments helps at restoring determinacy and stability under learning. These conclusions are further enforced in the presence of a high degree of pass-through from policy to bank lending rates.

Keywords: Monetary Policy; Capital Market Imperfections; Cost Channel; Asset Price. (search for similar items in EconPapers)
JEL-codes: E31 E32 E52 (search for similar items in EconPapers)
Pages: 24
Date: 2008-04
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (12)

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Related works:
Journal Article: CREDIT MARKET DISTORTIONS, ASSET PRICES AND MONETARY POLICY (2014)
Working Paper: Credit Market Distortions, Asset Prices and Monetary Policy (2012)
Working Paper: Credit Market Distortions, Asset Prices and Monetary Policy (2012)
Working Paper: Credit Market Distortions, Asset Prices and Monetary Policy (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:cam:camdae:0825

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