Presenter: Saki Bigio
Affiliation: University of California, Los Angeles, Department of Economics.
Date: October 05, 2021
Time: 15:00 IDT (GMT+3)
Abstract: This paper integrates a realistic implementation of monetary policy through the banking system into an incomplete-market economy with wage rigidity. Monetary policy sets policy rates and alters the supply of reserves. These tools grant independent control over credit spreads and an interest rate target. Through these tools, monetary policy affects the evolution of real interests rates, credit, output, and wealth distribution—both in the long and in the short run. We decompose the effects through a combination of the interest and credit channels that depend on the size of the central bank’s balance sheet. Monetary policy reaches an expansionary limit when it enters a liquidity trap. The model highlights a trade-off between worse microeconomic insurance (insurance across agents) and greater macroeconomic insurance (insurance across states). The model prescribes that monetary policy should operate with a small balance sheet that tightens credit during booms and should expand its balance sheet and lower policy rates during busts.
Coauthor: Yuliy Sannikov (Stanford Graduate School of Business).