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Tight Money-Tight Credit: Coordination Failure in the Conduct of Monetary and Financial Policies

Julio Carrillo (), Enrique Mendoza (), Victoria Nuguer and Jessica Rodan-Pena ()
Additional contact information
Enrique Mendoza: Department of Economics, University of Pennsylvania
Jessica Rodan-Pena: Banco de México

Authors registered in the RePEc Author Service: Jessica Roldán Peña ()

PIER Working Paper Archive from Penn Institute for Economic Research, Department of Economics, University of Pennsylvania

Abstract: Quantitative analysis of a New Keynesian model with the Bernanke-Gertler accelerator and risk shocks shows that violations of Tinbergen’s Rule and strategic interaction between policy-making authorities undermine significantly the effectiveness of monetary and financial policies. Separate monetary and financial policy rules, with the latter subsidizing lenders to encourage lending when credit spreads rise, produce higher welfare and smoother business cycles than a monetary rule augmented with credit spreads. The latter yields a tight money-tight credit regime in which the interest rate responds too much to inflation and not enough to adverse credit conditions. Reaction curves for the choice of policy-rule elasticity that minimizes each authority’s loss function given the other authority’s elasticity are nonlinear, reflecting shifts from strategic substitutes to complements in setting policy-rule parameters. The Nash equilibrium is significantly inferior to the Cooperative equilibrium, both are inferior to a first-best outcome that maximizes welfare, and both produce tight money-tight credit regimes.

Keywords: Financial Frictions; Monetary Policy; Financial Policy (search for similar items in EconPapers)
JEL-codes: E44 E52 E58 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
Date: 2017-02-03, Revised 2017-02-03
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Related works:
Working Paper: Tight money - tight credit: coordination failure in the conduct of monetary and financial policies (2018) Downloads
Working Paper: Tight Money-Tight Credit: Coordination Failure in the Conduct of Monetary and Financial Policies (2017) Downloads
Working Paper: Tight Money-Tight Credit: Coordination Failure in the Conduct of Monetary and Financial Policies (2017) Downloads
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