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 properties 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 holds exactly if real balances are remunerated at a constant spread below policy interest rates, approximately otherwise. We also highlight, however, that the natural rate is not robust to model un-certainty. 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: credit frictions; monetary policy; natural rate of interest (search for similar items in EconPapers)
Date: 2008-04
Note: 24907
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Related works:
Journal Article: Credit and the Natural Rate of Interest (2011)
Journal Article: Credit and the Natural Rate of Interest (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:2008889

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