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Ambrogio Cesa-Bianchi and Mr. Alessandro Rebucci
This paper develops a model featuring both a macroeconomic and a financial friction that speaks to the interaction between monetary and macro-prudential policies. There are two main results. First, real interest rate rigidities in a monopolistic banking system have an asymmetric impact on financial stability: they increase the probability of a financial crisis (relative to the case of flexible interest rate) in response to contractionary shocks to the economy, while they act as automatic macro-prudential stabilizers in response to expansionary shocks. Second, when the interest rate is the only available policy instrument, a monetary authority subject to the same constraints as private agents cannot always achieve a (constrained) efficient allocation and faces a trade-off between macroeconomic and financial stability in response to contractionary shocks. An implication of our analysis is that the weak link in the U.S. policy framework in the run up to the Global Recession was not excessively lax monetary policy after 2002, but rather the absence of an effective regulatory framework aimed at preserving financial stability.
Mr. Jan Vlcek and Mr. Scott Roger
This paper surveys dynamic stochastic general equilibrium models with financial frictions in use by central banks and discusses priorities for future development of such models for the purpose of monetary and financial stability analysis. It highlights the need to develop macrofinancial models which allow analysis of the macroeconomic effects of macroprudential policy tools and to evaluate elements of the Basel III reforms as a priority. The paper also reviews the main approaches to introducing financial frictions into general equilibrium models.
International Monetary Fund. External Relations Dept.
Murilo Portugal, Agustin Carstens, Kyrgyz Republic, HIPC, central Asia, Indonesian debt, Saudi Arabian economy, Peter Kenen, European Central Bank, ECB, Danish economy, flexicurity,Burundi's economy, aid volatility, Indian and China, Doing Business.
International Monetary Fund
One difficulty confronting Harberger’s celebrated model of the corporate income tax is how to treat the noncorporate production in primarily corporate sectors and corporate production in primarily noncorporate sectors. This paper presents a two-good model with corporate and noncorporate production of both goods. The incidence of the corporate tax in our Mutual Production Model (MPM) can differ markedly from that in the Harberger Model. The difference between the two models in deadweight loss is also striking, with losses in the MPM over ten times as large as in the Harberger Model.