Abstract
We develop a New Keynesian model where all payments between agents require bank deposits, bank deposits are created through disbursement of bank loans, and banks face convex lending costs. At the zero lower bound on deposit rates (ZLBD), changes in policy rates affect activity through both real interest rates and banks’ net interest margins (NIMs). At empirically plausible credit supply elasticities, the Phillips curve is very flat at the ZLBD. This is because inflation increases NIMs, credit, deposits, and thereby output, while higher NIMs also dampen inflation by relaxing price setters’ credit rationing constraint. At the ZLBD, monetary policy has far larger effects on output relative to inflation, and inflation feedback rules stabilize output less effectively than rules that also respond to credit. For post-COVID-19 policy, this suggests urgency in returning inflation to targets, caution with negative policy rates, and a strong influence of credit conditions on rate setting.
| Original language | English |
|---|---|
| Article number | 104208 |
| Pages (from-to) | 1-26 |
| Number of pages | 26 |
| Journal | Journal of Economic Dynamics and Control |
| Volume | 132 |
| Early online date | 6 Aug 2021 |
| DOIs | |
| Publication status | Published - Nov 2021 |
Funding
The authors thank Jagjit Chadha, Roger Farmer, Charles Goodhart, Kyle Hood, Udara Peiris, Dimitrios Tsomocos, our discussant Lukas Vogel, and seminar participants at the 2018 Oxford Macro Finance Workshop, the 50th Anniversary Conference of the Money, Macro & Finance Research Group, the EEA-ESEM 2019 Annual Conference, the SAET 2019 Annual Conference, the 2019 CEPR MMCN Research Conference, the Center for Macroeconomics/LSE London Macro Workshop, the RES 2019 Annual Conference, the CEBRA 2020 Annual Conference, and the 2020 ECFIN-JEDC-CEPR Conference on Secular Stagnation, Low Interest Rates and Low Inflation.
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