Credit Market Distortions, Asset Prices and Monetary Policy

Emiliano Santoro, Damjan Pfajfar

Research output: Contribution to journalArticle

Abstract

We study the conditions that ensure rational expectations equilibrium (REE) determinacy and expectational stability (E-stability) in a standard sticky-price model augmented with the cost channel. We allow for varying degrees of pass-through of the policy rate to bank-lending rates. Strong cost-side e§ects heavily constrain the policy rate response to inflation from above, so that inflation targeting policies may not be capable of ensuring REE uniqueness. In such cases, it is advisable to combine inflation responses with an appropriate reaction to the output gap and/or firm profitability. The negative reaction of real activity and asset prices to inflationary shocks adds a negative force to inflation responses that counteracts the borrowing cost effect and avoids expectations of higher inflation to become self-fulfilling.
Original languageEnglish
Pages (from-to)1-30
Number of pages30
JournalMacroeconomic Dynamics
Publication statusPublished - 2012

Keywords

  • Asset Prices
  • Cost Channel
  • Determinacy
  • E-stability
  • Monetary Policy

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