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Optimal Monetary Policy in a Model of the Credit Channel


  •  Corresponding author: Oreste Tristani, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany. Email:

  • We thank Michael Woodford for many interesting discussions and Krzysztof Zalewski for excellent research assistance. For useful comments and suggestions we also thank Kosuke Aoki, Ester Faia, Giovanni Lombardo, Pedro Teles, Christian Upper, Tony Yates and seminar participants at the EEA 2008 meetings, CEF 2008, the Norges Bank Workshop on ‘Optimal Monetary Policy’, the BIS-CEPR-ESI 12th Annual Conference on ‘The Evolving Financial System and the Transmission Mechanism of Monetary Policy’, the Swiss National Bank Research Conference 2008 on ‘Alternative Models for Monetary Policy Analysis’ and seminars at the Bank of England, the University of Aarhus and the Università Cattolica in Milan.


We study a simple extension of the basic new-Keynesian set-up in which we relax the assumption of frictionless financial markets: due to asymmetric information and default risk, bank lending rates incorporate a spread over the deposit rate. We demonstrate that financial frictions affect aggregate dynamics mainly through their impact on firms’ financing costs, which increase in both the deposit rate and in the spread between lending and deposit rates. Welfare includes a concern for smoothing these two financial market variables. Our numerical simulations suggest that an aggressive easing of policy is optimal in response to adverse financial market shocks.