Optimal Monetary Policy with Counter-Cyclical Credit Spreads

Marco Airaudo () and Maria Olivero

No 2014-1, School of Economics Working Paper Series from LeBow College of Business, Drexel University

Abstract: We study optimal monetary policy in a New Keynesian-DSGE model where the combination of a credit channel and customer-market features in banking gives rise to counter-cyclical credit spreads. In our setting, monopolistically competitive banks set lending rates in a forward-looking fashion as they internalize the fact that, due to borrowers. bank-specific (hence deep) habits, current interest rates also affect the future demand for loans by financially constrained. In particular, during a phase of economic expansion, banks might find it optimal to lower current lending rates to build up a larger customer base, which will be locked into a long-term relationship. The resulting counter-cyclicality of credit spreads makes optimal monetary policy depart substantially from the efficient allocation (and hence from price stability), under both discretion and commitment. Our analysis shows that the welfare costs of setting monetary policy under discretion (with respect to the optimal Ramsey plan) and of using simpler sub-optimal policy rules are strictly increasing in the magnitude of deep habits in credit markets and market power in banking.

Keywords: Optimal monetary policy; Cost Channel; New-Keynesian model; Credit frictions; Deep habits; Credit spreads (search for similar items in EconPapers)
JEL-codes: E32 E44 E50 (search for similar items in EconPapers)
Pages: 49 pages
Date: 2014-01-25
New Economics Papers: this item is included in nep-ban, nep-cba, nep-dge, nep-mac, nep-mon and nep-sog
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (10)

Downloads: (external link)
https://drive.google.com/file/d/0BxRDnd8cEKndUEowa ... rbZyaIzRgdwXkOA0ARuw Full text (application/pdf)

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

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:ris:drxlwp:2014_001

Access Statistics for this paper

More papers in School of Economics Working Paper Series from LeBow College of Business, Drexel University Contact information at EDIRC.
Bibliographic data for series maintained by Richard C. Barnett ().