TY - JOUR
T1 - Optimal monetary policy in a 'sudden stop'
AU - Braggion, Fabio
AU - Christiano, Lawrence J.
AU - Roldos, Jorge
N1 - Funding Information:
Braggion thanks the European Central Bank-Research Department and the International Monetary Fund for their hospitality. Christiano is grateful for the financial support of a National Science Foundation. The authors are grateful for the advice and comments of Klaus Adam, Martin Eichenbaum, Alejandro Izquierdo, Ken Judd, Narayana Kocherlakota, Juan Carlos Rodriguez, Andrew Scott, Jaume Ventura, Michael Woodford, the editor and an anonymous referee. The results reported in this paper do not necessarily reflect the opinion of the International Monetary Fund.
PY - 2009/5
Y1 - 2009/5
N2 - In the wake of the 1997-98 financial crises, interest rates in Asia were raised immediately, and then reduced sharply. We describe an environment in which this is the optimal monetary policy. The optimality of the immediate rise in the interest rate is an example of the theory of the second best: although high interest rates introduce an inefficiency wedge into the labor market, they are nevertheless welfare improving because they mitigate distortions due to binding collateral constraints. Over time, as the collateral constraint is less binding, the familiar Friedman forces dominate, and interest rates are optimally set as low as possible.
AB - In the wake of the 1997-98 financial crises, interest rates in Asia were raised immediately, and then reduced sharply. We describe an environment in which this is the optimal monetary policy. The optimality of the immediate rise in the interest rate is an example of the theory of the second best: although high interest rates introduce an inefficiency wedge into the labor market, they are nevertheless welfare improving because they mitigate distortions due to binding collateral constraints. Over time, as the collateral constraint is less binding, the familiar Friedman forces dominate, and interest rates are optimally set as low as possible.
KW - Collateral constraint
KW - Friedman rule
KW - Small open economy
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U2 - 10.1016/j.jmoneco.2009.03.010
DO - 10.1016/j.jmoneco.2009.03.010
M3 - Article
AN - SCOPUS:65649150310
SN - 0304-3932
VL - 56
SP - 582
EP - 595
JO - Journal of Monetary Economics
JF - Journal of Monetary Economics
IS - 4
ER -