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Lending Relationships and Optimal Monetary Policy

Guillaume Rocheteau, Tsz-Nga Wong () and Cathy Zhang

Purdue University Economics Working Papers from Purdue University, Department of Economics

Abstract: We study optimal monetary policy in a monetary model of internal and external finance with bank entry and endogenous formation of lending relationships through search and bargaining. Following an unanticipated destruction of relationships, optimal monetary policy under com- mitment lowers the interest rate in the aftermath of the shock and uses forward guidance to promote bank entry and rebuild relationships. Absent commitment, forward guidance fails to anchor inflation expectations and optimal policy is subject to a deflationary bias that delays recovery. If there is a temporary freeze in relationship creation, the interest rate is set at the zero lower bound for some period of time.

Keywords: credit relationships; banks; optimal monetary policy (search for similar items in EconPapers)
JEL-codes: D83 E32 E51 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban, nep-cba, nep-dge, nep-mac and nep-mon
Date: 2018-12
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Persistent link: https://EconPapers.repec.org/RePEc:pur:prukra:1306

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