Incomplete Credit Markets and Monetary Policy

RePEc Short ID: pbu13
ORCID iD: 0000-0002-1142-6803

Azariadis, Costas; Bullard, James B.; Singh, Aarti; Suda, Jacek

doi:10.20955/wp.2015.010

Working Paper

Incomplete Credit Markets and Monetary Policy

Abstract: We study monetary policy when private credit markets are incomplete. The macroeconomy we study has a large private credit market, in which participant households use non-state contingent nominal contracts (NSCNC). A second, small group of households only uses cash, supplied by the monetary authority, and cannot participate in the credit market. There is an aggregate shock. We find that, despite the substantial heterogeneity, the monetary authority can provide for optimal risk-sharing in the private credit market and thus overcome the NSCNC friction via a counter-cyclical price level rule. The counter-cyclical price level rule is not unique. To pin down a unique monetary policy rule, we consider two secondary goals for the monetary authority, (i) expected inflation targeting and, (ii) nominal GDP targeting. We examine the impact of each of these approaches on the price level rule and other nominal variables in the economy.

Keywords: Monetary policy; incomplete credit markets; non-state contingent nominal contracts; life cycle economies; heterogeneous households; nominal GDP targeting;

JEL Classification: E4; E5;

https://doi.org/10.20955/wp.2015.010