Financial Frictions and Interest Rate Shocks

29 Pages Posted: 4 Oct 2017

See all articles by Bernardino Adao

Bernardino Adao

Bank of Portugal - Research Department

Andre C. Silva

Nova School of Business and Economics

Date Written: September 1, 2017

Abstract

We show that taking into account the optimal response of agents subject to financial frictions reproduces two empirical facts on the response to interest rate shocks: the decrease in the stock of money on impact and the gradual decrease in the real stock of money. Financial frictions are introduced as a cost of portfolio rebalancing. The model generates infrequent portfolio rebalancing and endogenous sticky prices. We obtain optimal rebalancing periods, prices, and money over time. Predetermined rebalancing periods imply counterfactual predictions. Considering the optimal response of agents is relevant to determine the response of monetary policy shocks.

Keywords: Financial Frictions, Interest Rate Shocks, Monetary Transmission, Monetary Policy

JEL Classification: E30, E40, E50

Suggested Citation

Adao, Bernardino and Silva, Andre C., Financial Frictions and Interest Rate Shocks (September 1, 2017). Available at SSRN: https://ssrn.com/abstract=3047109 or http://dx.doi.org/10.2139/ssrn.3047109

Bernardino Adao

Bank of Portugal - Research Department ( email )

Av. Almirante Reis 71, 6th
Lisbon 1150-012
Portugal

Andre C. Silva (Contact Author)

Nova School of Business and Economics ( email )

Campus de Carcavelos
Carcavelos, 2775-405
Portugal

HOME PAGE: http://sites.google.com/view/andredecastrosilva

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