Monetary policy in a financial crisis

Lawrence J. Christiano*, Christopher Gust, Jorge Roldos

*Corresponding author for this work

Research output: Contribution to journalArticle

51 Scopus citations

Abstract

What are the economic effects of an interest rate cut when an economy is in the midst of a financial crisis? Under what conditions will a cut stimulate output and employment, and raise welfare? Under what conditions will a cut have the opposite effects? We answer these questions in a general class of open economy models, where a financial crisis is modelled as a time when collateral constraints are suddenly binding. We find that when there are frictions in adjusting the level of output in the traded good sector and in adjusting the rate at which that output can be used in other parts of the economy, then a cut in the interest rate is most likely to result in a welfare-reducing fall in output and employment. When these frictions are absent, a cut in the interest rate improves asset positions and promotes a welfare-increasing economic expansion.

Original languageEnglish (US)
Pages (from-to)64-103
Number of pages40
JournalJournal of Economic Theory
Volume119
Issue number1 SPEC. ISS.
DOIs
StatePublished - Nov 2004

Keywords

  • Collateral constraint
  • Exchange rates
  • Financial crisis

ASJC Scopus subject areas

  • Economics and Econometrics

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