Smoothed Interest Rate Setting by Central Banks and Staggered Loan Contracts

Authors


  • This article was previously circulated as ‘Staggered Loan Contract in a Utility Maximizing Framework’. I have benefited from seminar participants at Columbia University. I thank Alex Mikov, Bruce Preston, Guillermo Calvo, Jón Steinsson, Marc Giannoni and Steve Zeldes for good suggestions and critiques, and especially Mike Woodford, Editor Wouter den Haan and anonymous referees for helpful comments and suggestions. Any errors are solely the responsibility of the author.

Abstract

I investigate a new source of economic stickiness: namely, staggered loan interest rate contracts under monopolistic competition. This study introduces this mechanism into a standard new Keynesian model. Simulations show that a response to a financial shock is greatly amplified by the staggered loan contracts, although a response to a productivity, cost-push or monetary policy shock is not much affected. I derive an approximated loss function and analyse optimal monetary policy. Unlike other models, the function includes a quadratic loss of the first-order difference in loan rates. Thus, central banks have an incentive to smooth the policy rate.

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