Working Paper: CEPR ID: DP8652
Authors: Hans J. Blommestein; Sylvester C.W. Eijffinger; Zongxin Qian
Abstract: This paper builds a dynamic general equilibrium macro-finance model with two types of borrowers: entrepreneurs who want to produce and gamblers who want to play a lottery. It links central bank's interest rate policy to expected cash flows of both types. This link enables us to study how the interactions between various shocks and different monetary policy rules affect the borrower pool faced by financial intermediaries. We find that when the economy is hit by an expansionary monetary policy shock, the proportion of entrepreneurs in the borrower pool will be persistently lower than the steady state level after a short period. It is lowest when the central bank does not react to output fluctuations. Quite differently, not reacting to output fluctuations avoids a persistent worsening of the borrower pool in the long run if the shock is a bad productivity shock.
Keywords: adverse selection; financial crisis; monetary policy
JEL Codes: E44; E52; G01
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Expansionary monetary policy shock (E49) | Proportion of entrepreneurs in the borrower pool (G21) |
| Central bank's interest rate policy (E52) | Expected cash flows of entrepreneurs and gamblers (G40) |
| Expansionary monetary policy (E52) | Expected losses from lending to gamblers (G21) |
| Expansionary monetary policy (E52) | Entrepreneurial entry (L26) |
| Expansionary monetary policy (E52) | Reduced proportion of entrepreneurs in the long run (L26) |