Description
Title: The Role of Monetary Policy in Understanding the Effects of Credit Standards on Aggregate Fluctuations in a Small Open Economy
Abstract: Credit standards, such as lending margins and collateral requirements, move countercyclically, according to empirical evidence. In this study, the countercyclical movement in credit standards is produced by building a small open economy model with financial frictions. Our analysis shows that countercyclical changes in credit standards serve to amplify economic shocks. In particular, output volatility is increased by 21% when endogenous credit standards are present. Additionally, we offer three different tools that policymakers can use to mitigate the effects of endogenous credit standards on macroeconomic volatility. First, by successfully balancing out lending fluctuations, the addition of credit growth to monetary policy significantly reduces the additional volatility. Second, if properly designed, the exchange rate-augmented monetary policy is thought to be an effective tool for removing the majority of the extra fluctuations brought on by ingrained banking sector practices. Last but not least, the implementation of the foreign interest augmented policy succeeds in reducing the impact of endogenous changes in lending standards.
Keywords: credit standards; deep habits; monetary policy; DSGE modeling; small open economy; aggregate fluctuations; collateral requirements
Paper Quality: SCOPUS / Web of Science Level Research Paper
Subject: Economics
Writer Experience: 20+ Years
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