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Finance and Credit in a Model of Monetary Policy

Jagjit Chadha () and Young-Kwan Kang

No 471, NIESR Discussion Papers from National Institute of Economic and Social Research

Abstract: Economies is the extent to which a workhorse advanced economy model can yield important insights for monetary policy-making. We note that the standard sticky-price, monopolistically competitive model does not allow analysis of money and credit dynamics and led to a concentration of research on simple interest rate reaction functions. Time-varying financial frictions tend to act as a tax on intermediation activities and so can vary output in a significant manner. In this paper, we consider the implications of financial frictions for baseline monetary policy using a model calibrated on Indian data and find that a simple interest rate reaction function may not be welfare maximising.

Date: 2016-10
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