Credit and the Natural Rate of Interest

49 Pages Posted: 13 May 2008

See all articles by Fiorella De Fiore

Fiorella De Fiore

Bank for International Settlements (BIS) - Monetary and Economic Department

Oreste Tristani

European Central Bank (ECB)

Date Written: April 2008

Abstract

We analyze the properties of the natural rate of interest in an economy where nominal debt contracts generate a spread between loan rates and the policy interest rate. In our model, monetary policy has real effect in the flexible-price equilibrium, because it affects the credit spread. Relying on a definition suitable for this environment, we demonstrate that: (i) the natural rate is independent of monetary policy and (ii) it delivers price stability, if used as the intercept of a monetary policy rule. The second result holds exactly if real balances are remunerated at a constant spread below policy interest rates, approximately otherwise. We also highlight, however, that the natural rate is not robust to model uncertainty. The natural rate reacts differently to aggregate shocks - not only quantitatively but also qualitatively - depending on the underlying model assumptions (e.g. whether or not financial markets are frictionless).

Keywords: Monetary policy, natural rate of interest, credit frictions

JEL Classification: E40, E50, G10

Suggested Citation

De Fiore, Fiorella and Tristani, Oreste, Credit and the Natural Rate of Interest (April 2008). ECB Working Paper No. 889, Available at SSRN: https://ssrn.com/abstract=1120163 or http://dx.doi.org/10.2139/ssrn.1120163

Fiorella De Fiore (Contact Author)

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

Oreste Tristani

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
0049 69 13440 (Phone)
0049 69 1344 6000 (Fax)