Q-targeting in new Keynesian models with credit market frictions
Within the model, monetary policy is characterized by a Taylor rule according to which the nominal interest rate is set as a function of the deviation of the inflation rate from its target rate, the output gap, and Tobin’s q. The latter is measured by the relative price of newly installed capital. We show that the consideration of Tobin’s q implies considerable welfare effects and that monetary policy should optimally increase interest rates with higher capital prices.
Objectives:
1. Develop a model that is able to generate an anti-cyclical external finance premium (lending rate for entrepreneurs) as observed empirically. Standard business-cycle model with credit frictions fail to replicate this kind of observed behavior, which, of course, is fundamental to the explanation of periods of financial crises such as the 2008/2009 crisis.
2. Study optimal monetary policies. In particular, should monetary policy target capital prices? In the recent financial crisis, many economists have drawn attention to the question whether the FED or the ECB should target asset prices (stocks or real estate). We add to this discussion by studying the role of Tobin’s q (which is readily observable) as an input into the Taylor rule.
Data/Methods:
1. Dynamic Stochastic General Equilibrium Modeling and computational methods as in our book (Dynamic Stochastic General Equilibrium: Computational Methods and Applications, Springer, 2nd ed., 2009)
2. Standard business-cycle data for the US economy for the calibration of the model
Expected Results:
We show that the consideration of Tobin’s q in the central bank’s target rule implies considerable welfare effects and that monetary policy should optimally increase interest rates with higher capital prices.