Imperfect credit markets: implications for monetary policy

I develop a model for monetary policy analysis that features significant feedback from asset prices to macroeconomic quantities. The feedback is caused by credit market imperfections, which dynamically affect how efficiently labour and capital are being used in aggregate. I then analyse what implications this mechanism has for monetary policy. The paper offers three insights. First, the monetary transmission mechanism works not only via nominal rigidites but also via a reallocation of productive resources away from the most productive agents. Second, following an adverse productivity shock there is a dynamic trade-off between the immediate fall in output, which is an effcient response to the productivity fall, and the fall in output thereafter, which is caused by a reallocation of resources away from the most productive agents. The more the initial output fall is dampened with a temporary rise in inflation, the more the adverse future effects of the reallocation of resources are mitigated. Third, in a full welfare-based analysis of optimal monetary policy I show that it is optimal to have some inflation variability, even if the only shocks in the economy are productivity shocks. The optimal variability of inflation is small, but the costs of stabilising inflation too aggressively can be large.monetary policy; credit frictions; credit crunch; optimal monetary policy

Imperfect credit markets: implications for monetary policy

I develop a model for monetary policy analysis that features significant feedback from asset prices to macroeconomic quantities. The feedback is caused by credit market imperfections, which dynamically affect how efficiently labour and capital are being used in aggregate. I then analyse what implications this mechanism has for monetary policy. The paper offers three insights. First, the monetary transmission mechanism works not only via nominal rigidites but also via a reallocation of productive resources away from the most productive agents. Second, following an adverse productivity shock there is a dynamic trade-off between the immediate fall in output, which is an effcient response to the productivity fall, and the fall in output thereafter, which is caused by a reallocation of resources away from the most productive agents. The more the initial output fall is dampened with a temporary rise in inflation, the more the adverse future effects of the reallocation of resources are mitigated. Third, in a full welfare-based analysis of optimal monetary policy I show that it is optimal to have some inflation variability, even if the only shocks in the economy are productivity shocks. The optimal variability of inflation is small, but the costs of stabilising inflation too aggressively can be large

Imperfect credit markets: implications for monetary policy

I develop a model for monetary policy analysis that features significant feedback from asset prices to macroeconomic quantities. The feedback is caused by credit market imperfections, which dynamically affect how efficiently labour and capital are being used in aggregate. I then analyse what implications this mechanism has for monetary policy. The paper offers three insights. First, the monetary transmission mechanism works not only via nominal rigidites but also via a reallocation of productive resources away from the most productive agents. Second, following an adverse productivity shock there is a dynamic trade-off between the immediate fall in output, which is an effcient response to the productivity fall, and the fall in output thereafter, which is caused by a reallocation of resources away from the most productive agents. The more the initial output fall is dampened with a temporary rise in inflation, the more the adverse future effects of the reallocation of resources are mitigated. Third, in a full welfare-based analysis of optimal monetary policy I show that it is optimal to have some inflation variability, even if the only shocks in the economy are productivity shocks. The optimal variability of inflation is small, but the costs of stabilising inflation too aggressively can be large

Indicators of fragility in the UK corporate sector

The determinants of the aggregate corporate liquidation rate in the United Kingdom are estimated from a sample of quarterly data using an autoregressive distributed lag (ARDL) approach which allows for non-stationarity of the variables. The paper investigates what the appropriate measures of indebtedness are, and examines whether the unprecedented spike in the corporate liquidation rate in the United Kingdom in 1992 caused a breakdown in the relationship between the variables. The debt-to-GDP ratio, the real interest rate, deviations of GDP from trend and real wages are found to be long-run determinants of the liquidation rate. The birth rate of new companies, an index of property prices and nominal interest rates have significant short-term effects. The estimated equation is robust to changes in the sample period. The rapidly increasing level of indebtedness in the late 1980s was the main determinant of the subsequent increase in the liquidation rate. The decrease in the liquidation rate after 1992 was primarily due to lower real interest rates, lower real wages and the cyclical recovery of GDP.

Imperfect Credit Markets and the Transmission of Marcroeconomic Shocks

Abstract This paper outlines a monetary model of a production economy with an explicit role for credit in allocating investment funds to the agents with the most productive projects. Due to limited commitment, credit markets are imperfect and collateral is required. This provides a role for asset prices and borrower net worth in investment decisions. In particular, the wealth distribution directly affects the productive capacity of the economy, by influencing the respective holdings of capital by agents with high and low productivity. Small, temporary shocks that affect output or asset prices can have large and persistent effects on current and future output. The interaction between the wealth distribution and the productive capacity of the economy has important implications for the role of monetary policy. Since some of the output variability is the result of credit frictions, it is not efficient. In contrast to standard sticky-price models, it may not be not optimal for monetary policy to try and achieve the flexible-price level of output