Optimal Monetary Policy in a 'Sudden Stop'

50 Pages Posted: 23 Jul 2007 Last revised: 19 Sep 2022

See all articles by Fabio Braggion

Fabio Braggion

Tilburg University - Tilburg University School of Economics and Management; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Lawrence J. Christiano

Northwestern University; Federal Reserve Bank of Cleveland; Federal Reserve Bank of Chicago; Federal Reserve Bank of Minneapolis; National Bureau of Economic Research (NBER)

Jorge E. Roldos

International Monetary Fund (IMF)

Date Written: July 2007

Abstract

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 various real frictions wear off and the collateral constraint is less binding, the familiar Friedman forces dominate, and interest rates are optimally set as low as possible.

Suggested Citation

Braggion, Fabio and Christiano, Lawrence J. and Roldos, Jorge E., Optimal Monetary Policy in a 'Sudden Stop' (July 2007). NBER Working Paper No. w13254, Available at SSRN: https://ssrn.com/abstract=1002043

Fabio Braggion

Tilburg University - Tilburg University School of Economics and Management ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Lawrence J. Christiano (Contact Author)

Northwestern University ( email )

2003 Sheridan Road
Evanston, IL 60208
United States
847-491-8231 (Phone)
847-491-7001 (Fax)

Federal Reserve Bank of Cleveland

East 6th & Superior
Cleveland, OH 44101-1387
United States

Federal Reserve Bank of Chicago

230 South LaSalle Street
Chicago, IL 60604
United States

Federal Reserve Bank of Minneapolis

90 Hennepin Avenue
Minneapolis, MN 55480
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Jorge E. Roldos

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
33
Abstract Views
791
PlumX Metrics