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
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