Banking Competition, Collateral Constraints and Optimal Monetary Policy

45 Pages Posted: 18 Feb 2010

See all articles by Javier Andrés

Javier Andrés

University of Valencia - Department of Economics

Oscar Arce

Banco de España

Carlos Thomas

Banco de España

Date Written: February 16, 2010

Abstract

We analyze optimal monetary policy in a model with two distinct financial frictions. First, borrowing is subject to collateral constraints. Second, credit flows are intermediated by monopolistically competitive banks, thus giving rise to endogenous lending spreads. We show that, up to a second order approximation, welfare maximization is equivalent to stabilization of four goals: inflation, output gap, the consumption gap between constrained and unconstrained agents, and the distribution of the collateralizable asset between both groups. Following both financial and non-financial shocks, the optimal monetary policy commitment implies a short-run trade-off between stabilization goals. Such policy tradeoffs become amplified as banking competition increases, due to the fall in lending spreads and the resulting increase in financial leveraging.

Keywords: banking competition, lending spreads, collateral constraints, monetary policy, linear-quadratic method

JEL Classification: E32, E52, G1, G21

Suggested Citation

Andrés, Javier and Arce, Oscar and Thomas, Carlos, Banking Competition, Collateral Constraints and Optimal Monetary Policy (February 16, 2010). Banco de Espana Working Paper No. 1001. Available at SSRN: https://ssrn.com/abstract=1553789 or http://dx.doi.org/10.2139/ssrn.1553789

Javier Andrés

University of Valencia - Department of Economics ( email )

E-46022 Valencia, Valencia E-46022
Spain
(34 96) 382 8260 (Phone)
(34 96) 382 8249 (Fax)

Oscar Arce

Banco de España ( email )

Alcala 50
Madrid 28014
Spain

Carlos Thomas (Contact Author)

Banco de España ( email )

Alcala 50
Madrid 28014
Spain

HOME PAGE: http://www.bde.es

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