Working Paper: CEPR ID: DP10250
Authors: Vo Phuong Mai Le; David Meenagh; Patrick Minford
Abstract: This paper gives money a role in providing cheap collateral in a model of banking; this means that, besides the Taylor Rule, monetary policy can affect the risk-premium on bank lending to firms by varying the supply of M0 in open market operations, so that even when the zero bound prevails monetary policy is still effective; and fiscal policy under the zero bound still crowds out investment via the risk-premium. A simple rule for making M0 respond to credit conditions can substantially enhance the economy's stability. Both price-level and nominal GDP targeting rules for interest rates would combine with this to stabilise the economy further. With these rules for monetary control, aggressive and distortionary regulation of banks' balance sheets becomes redundant.
Keywords: Crises; DSGE Model; Financial Frictions; Fiscal Multiplier; Indirect Inference; Monetary Policy; Money Supply; QE; Zero Bound
JEL Codes: C1; E3; E44; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Monetary Policy (E52) | Risk Premium on Bank Lending (G21) |
| Increase in M0 (E51) | Lower Risk Premium (G19) |
| Risk Premium (G19) | Investment (G31) |
| Fiscal Policy (E62) | Higher Risk Premium (G19) |
| Higher Risk Premium (G19) | Lower Investment (G31) |
| M0 Supply (E51) | Economic Stability (E64) |
| Rule for M0 Response to Credit Conditions (E51) | Economic Stability (E64) |
| Regulatory Policies (G18) | Credit Premium (G19) |