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Optimal monetary policy with the cost channel and monopolistically-competitive banks

Salem Abo-Zaid ()

Journal of Macroeconomics, 2015, vol. 45, issue C, 284-299

Abstract: This paper studies the optimal nominal policy interest rate in a model with the cost channel and imperfect competition in the banking sector. Due to this market power, the interest rate on deposits is relatively low; in particular it is lower than the policy interest rate. This, in turn, leads to a suboptimal level of deposits and, as a result, to a low level of intermediation. Deviations from the Friedman Rule are optimal in this setup regardless of the assumption about price rigidity; since households can hold their assets in the form of cash or deposits, taxing money, which is an imperfect substitute for deposits, is optimal in order to increase the level of deposits and encourage intermediation. The main results of the paper are robust to the introduction of market power in the loan market as well as stickiness in both the deposit and the loan markets.

Keywords: Friedman Rule; Imperfectly-competitive banking sector; Nominal deposit interest rate; Nominal policy interest rate; Working capital; Money in the utility (search for similar items in EconPapers)
JEL-codes: E31 E32 E41 E43 E52 E58 (search for similar items in EconPapers)
Date: 2015
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Handle: RePEc:eee:jmacro:v:45:y:2015:i:c:p:284-299