Credit Spreads and Monetary Policy

Authors


  • Prepared for the FRB-JMCB research conference “Financial Markets and Monetary Policy,” Washington, DC, June 4–5, 2009. We thank Argia Sbordone, John Taylor, and John Williams for helpful discussions, and the NSF for research support of the second author. The views expressed in this paper are those of the authors and do not necessarily reflect positions of the Federal Reserve Bank of New York or the Federal Reserve System.

Abstract

We consider the desirability of modifying a standard Taylor rule for interest rate policy to incorporate adjustments for measures of financial conditions. We consider the consequences of such adjustments for the way policy would respond to a variety of disturbances, using the dynamic stochastic general equilibrium model with credit frictions developed in Cúrdia and Woodford (2009a). According to our model, an adjustment for variations in credit spreads can improve upon the standard Taylor rule, but the optimal size of adjustment depends on the source of the variation in credit spreads. A response to the quantity of credit is less likely to be helpful.

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