Optimal Central Bank Lending
43 Pages Posted: 28 Jun 2010
Date Written: June 28, 2010
We analyze optimal monetary policy in a sticky price model where the central bank supplies money outright via asset purchases and lends money temporarily against collateral. The terms of central bank lending affect rationing of money and impact on macroeconomic aggregates. The central bank can set the policy rate and its inflation target in a way that implements the first best long-run allocation, which is impossible if money were supplied in a lump-sum way (as commonly assumed). Efficient central bank lending further increases gains from macroeconomic stabilization beyond pure interest rate policy. This requires departing from a “Treasuries-only” regime.
Keywords: Optimal monetary policy, central bank instruments, collateralized lending, liquidity premium, inflation
JEL Classification: E4, E5, E32
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