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OPTIMAL MONETARY POLICY AND IMPERFECT FINANCIAL MARKETS: A CASE FOR NEGATIVE NOMINAL INTEREST RATES?

Salem Abo-Zaid and Julio Garin

Economic Inquiry, 2016, vol. 54, issue 1, 215-228

Abstract: type="main" xml:id="ecin12244-abs-0001"> This article studies optimal monetary policy in a model with credit frictions and money demand. We show that augmenting a standard New Keynesian model with money demand and financial frictions generates a mechanism that, in equilibrium, gives rise to optimal negative nominal interest rates. In addition, we find that the tighter credit markets are, the lower the optimal nominal policy interest rate and the more likely it is to be negative. Quantitatively, when credit constraints are binding, a standard calibration of the model generates an optimal nominal policy interest rate that is roughly −4% annually. (JEL E31, E41, E43, E44, E52, E58)

Date: 2016
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