Credit Spreads and Monetary Policy

62 Pages Posted: 2 Sep 2009  

Vasco Cúrdia

Federal Reserve Bank of San Francisco

Michael Woodford

Columbia University, Graduate School of Arts and Sciences, Department of Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: August 1, 2009

Abstract

We consider the desirability of modifying a standard Taylor rule for a central bank’s interest rate policy to incorporate either an adjustment for changes in interest rate spreads (as proposed by Taylor [2008] and McCulley and Toloui [2008]) or a response to variations in the aggregate volume of credit (as proposed by Christiano et al. [2007]). We then examine how, under those adjustments, policy would respond to various types of economic disturbances, including those originating in the financial sector that increase equilibrium spreads and contract the supply of credit. We conduct our analysis using a simple DSGE model with credit frictions (Cúrdia and Woodford 2009), comparing the equilibrium responses to various disturbances under the modified Taylor rules with those under a policy that would maximize average expected utility. According to our model, a spread adjustment can improve on the standard Taylor rule, but the optimal size of the adjustment is unlikely to be as large as the one proposed, and the same type of adjustment is not desirable regardless of the source of variation in credit spreads. A response to credit is less likely to be helpful, and its desirable size (and even sign) is less robust to alternative assumptions about the nature and persistence of economic disturbances.

Keywords: credit frictions, monetary policy

JEL Classification: E50, E40

Suggested Citation

Cúrdia, Vasco and Woodford, Michael, Credit Spreads and Monetary Policy (August 1, 2009). FRB of New York Staff Report No. 385. Available at SSRN: https://ssrn.com/abstract=1465683 or http://dx.doi.org/10.2139/ssrn.1465683

Vasco Cúrdia (Contact Author)

Federal Reserve Bank of San Francisco ( email )

101 Market Street
MS 1130
San Francisco, CA 94105
United States
(415) 977-3624 (Phone)

HOME PAGE: http://www.frbsf.org/economics/economists/staff.php?vcurdia

Michael Woodford

Columbia University, Graduate School of Arts and Sciences, Department of Economics ( email )

420 W. 118th Street
New York, NY 10027
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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