A Model of Credit, Money, Interest, and Prices

90 Pages Posted: 8 Mar 2021 Last revised: 26 Jun 2021

See all articles by Saki Bigio

Saki Bigio

University of California, Los Angeles (UCLA) - Department of Economics

Yuliy Sannikov

Stanford GSB

Date Written: March 2021


This paper integrates a realistic implementation of monetary policy through the banking system into an incomplete-markets economy with wage rigidity. Monetary policy sets policy rates and alters the supply of reserves. These tools grant independent control over credit spreads and an interest target. Through these tools, monetary policy affects the evolution of real interests rates, credit, output, and the wealth distribution—both in the long and in the short run. We decompose the effects through a combination of the interest and credit channels that depend on the size of the central bank’s balance sheet. Monetary policy reaches an expansionary limit when it enters a liquidity trap. The model highlights a trade-off between worse microeconomic insurance (insurance across agents) and greater macroeconomic insurance (insurance across states). The model prescribes that monetary policy should operate with a small balance sheet which tightens credit during booms, and should expand its balance sheet and lower policy rates during busts.

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Suggested Citation

Bigio, Saki and Sannikov, Yuliy, A Model of Credit, Money, Interest, and Prices (March 2021). NBER Working Paper No. w28540, Available at SSRN: https://ssrn.com/abstract=3799831

Saki Bigio (Contact Author)

University of California, Los Angeles (UCLA) - Department of Economics ( email )

8283 Bunche Hall
Los Angeles, CA 90095-1477
United States

Yuliy Sannikov

Stanford GSB ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

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