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Optimal Monetary Policy with Countercyclical Credit Spreads
Author(s) -
AIRAUDO MARCO,
OLIVERO MARÍA PÍA
Publication year - 2019
Publication title -
journal of money, credit and banking
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.763
H-Index - 108
eISSN - 1538-4616
pISSN - 0022-2879
DOI - 10.1111/jmcb.12598
Subject(s) - dynamic stochastic general equilibrium , discretion , monetary policy , economics , monetary economics , new keynesian economics , welfare , business cycle , bond market , taylor rule , credit channel , macroeconomics , central bank , inflation targeting , market economy , political science , law
We study optimal monetary policy in a New‐Keynesian Dynamic Stochastic General Equilibrium (DSGE) model with a credit channel and relationship lending in banking. We show that borrowers' bank‐specific (deep) habits give rise to countercyclical credit spreads, which, in turn, make optimal monetary policy depart substantially from price stability, under both discretion and commitment. Our analysis shows that the welfare costs of setting monetary policy under discretion (with respect to the optimal Ramsey plan) and of using simpler suboptimal policy rules are strictly increasing in the magnitude of deep habits in credit markets and market power in banking.