Working Paper: NBER ID: w13207
Authors: Marvin Goodfriend; Bennett T. McCallum
Abstract: The paper reconsiders the role of money and banking in monetary policy analysis by including a banking sector and money in an optimizing model otherwise of a standard type. The model is implemented quantitatively, with a calibration based on U.S. data. It is reasonably successful in providing an endogenous explanation for substantial steady-state differentials between the interbank policy rate and (i) the collateralized loan rate, (ii) the uncollateralized loan rate, (iii) the T-bill rate, (iv) the net marginal product of capital, and (v) a pure intertemporal rate. We find a differential of over 3 % pa between (iii) and (iv), thereby contributing to resolution of the equity premium puzzle. Dynamic impulse response functions imply pro-or-counter-cyclical movements in an external finance premium that can be of quantitative significance. In addition, they suggest that a central bank that fails to recognize the distinction between interbank and other short rates could miss its appropriate settings by as much as 4% pa. Also, shocks to banking productivity or collateral effectiveness call for large responses in the policy rate.
Keywords: Monetary Policy; Banking; Interest Rates; External Finance Premium
JEL Codes: E44; E52; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| banking sector shocks (F65) | monetary policy responses (E52) |
| movements in the external finance premium (G15) | monetary policy responses (E52) |
| interbank policy rate (E43) | net marginal product of capital (D24) |
| T-bill rate (E43) | net marginal product of capital (D24) |
| failure to recognize distinctions between interbank and other short rates (E43) | misjudgment of policy settings (E65) |