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Do credit market imperfections justify a central bank׳s response to asset price fluctuations?

Kengo Nutahara

Journal of Economic Dynamics and Control, 2015, vol. 61, issue C, 81-94

Abstract: Do credit market imperfections justify a central bank׳s response to asset price fluctuations? This study addresses this question from the perspective of equilibrium determinacy. In the model we use, prices are sticky and the working capital of firms is subject to asset values because of a lack of commitment. If credit market imperfections exist to a small degree, the Taylor principle is a necessary and sufficient condition for equilibrium determinacy, and monetary policy response to asset price fluctuations is good from the perspective of equilibrium determinacy. However, if credit market imperfections exist to a large degree such that the collateral constraint is binding, then the Taylor principle no longer guarantees equilibrium determinacy, and monetary policy response to asset price fluctuations becomes a source of equilibrium indeterminacy. We find that the existence of credit market imperfections makes it unsuitable to initiate a monetary policy response to deal with asset price fluctuations. We also find that reductions in credit market imperfections can enlarge the indeterminacy region of the model parameters.

Keywords: Asset prices; Credit market imperfections; Collateral constraints; Equilibrium indeterminacy; Monetary policy; Taylor principle (search for similar items in EconPapers)
JEL-codes: E32 E44 E52 (search for similar items in EconPapers)
Date: 2015
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Journal of Economic Dynamics and Control is currently edited by J. Bullard, C. Chiarella, H. Dawid, C. H. Hommes, P. Klein and C. Otrok

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