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Monetary Policy in a Financial Crisis

69 Pages Posted: 13 Jun 2002 Last revised: 27 Oct 2010

Lawrence J. Christiano

Northwestern University; Federal Reserve Bank of Cleveland; Federal Reserve Bank of Chicago; Federal Reserve Bank of Minneapolis; National Bureau of Economic Research (NBER)

Christopher J. Gust

Federal Reserve Board - Trade and Financial Studies

Jorge E. Roldos

International Monetary Fund (IMF)

Multiple version iconThere are 2 versions of this paper

Date Written: June 2002

Abstract

What are the economic effects of an interest rate cut when an economy is in the midst of a financial crisis? Under what conditions will a cut stimulate output and employment, and raise welfare? Under what conditions will a cut have the opposite e ffects? We answer these questions in a general class of open economy models, where a financial crisis is modeled as a time when collateral constraints are suddenly binding. We find that when there are frictions in adjusting the level of output in the traded good sector and in adjusting the rate at which that output can be used in other parts of the economy, then a cut in the interest rate is most likely to result in a welfare-reducing fall in output and employment. When these frictions are absent, a cut in the interest rate improves asset positions and promotes a welfare-increasing economic expansion.

Suggested Citation

Christiano, Lawrence J. and Gust, Christopher J. and Roldos, Jorge E., Monetary Policy in a Financial Crisis (June 2002). NBER Working Paper No. w9005. Available at SSRN: https://ssrn.com/abstract=316002

Lawrence J. Christiano (Contact Author)

Northwestern University ( email )

2003 Sheridan Road
Evanston, IL 60208
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Federal Reserve Bank of Cleveland

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Federal Reserve Bank of Chicago

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Federal Reserve Bank of Minneapolis

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National Bureau of Economic Research (NBER)

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Christopher J. Gust

Federal Reserve Board - Trade and Financial Studies ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States

Jorge E. Roldos

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

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