Debt deflation effects of monetary policy

Li Lin, Dimitrios Tsomocos and Alexandros P. Vardoulakis

Chapter 9 in Financial Regulation and Stability, 2019, pp 245-258 from Edward Elgar Publishing

Abstract: We assess the role that monetary policy plays in the decision to default using a General Equilibrium model with collateralized loans, trade in fiat money and production. The monetary authority extends long-term credit against risky collateral along with its traditional monetary operations. The value of collateral depends on traditional monetary policy and agents can optimally choose to default depending on the relative value of the collateral to the face value of the loan. Default results in foreclosure, higher borrowing costs, inefficient investment and a decrease in total output. We show that pre-crisis contractionary monetary policy interacts with Fisherian debt-deflation dynamics and can increase the probability that a crisis occurs.

Keywords: Economics and Finance (search for similar items in EconPapers)
Date: 2019
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Related works:
Journal Article: Debt deflation effects of monetary policy (2015)
Working Paper: Debt Deflation Effects of Monetary Policy (2014)
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