Financial Frictions and Interest Rate Shocks
29 Pages Posted: 4 Oct 2017
Date Written: September 1, 2017
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: Suggested Citation