Optimal Monetary Policy in a 'Sudden Stop'

Fabio Braggion (), Lawrence Christiano () and Jorge Roldos

No 13254, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: In the wake of the 1997-98 financial crises, interest rates in Asia were raised immediately, and then reduced sharply. We describe an environment in which this is the optimal monetary policy. The optimality of the immediate rise in the interest rate is an example of the theory of the second best: although high interest rates introduce an inefficiency wedge into the labor market, they are nevertheless welfare improving because they mitigate distortions due to binding collateral constraints. Over time, as various real frictions wear off and the collateral constraint is less binding, the familiar Friedman forces dominate, and interest rates are optimally set as low as possible.

JEL-codes: E4 E44 E5 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac, nep-mon and nep-sea
Date: 2007-07
Note: EFG
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Journal Article: Optimal monetary policy in a [`]sudden stop' (2009)
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