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Do Credit Market Imperfections Justify a Central Bank’s Response to Asset Price Fluctuations?

Kengo Nutahara

No 15-003E, CIGS Working Paper Series from The Canon Institute for Global Studies

Abstract: Do credit market imperfections justify a central banks 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.

New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
Date: 2015-09
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