Optimal monetary policy in a ‘sudden stop’

In the wake of the 1997–98 financial crises, interest rates in Asia were raised immediately, and then reduced sharply. We describe an environment in which this is the optimal monetary policy. The optimality of the immediate rise in the interest rate is an example of the theory of the second best: al...

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Bibliographic Details
Published inJournal of monetary economics Vol. 56; no. 4; pp. 582 - 595
Main Authors Braggion, Fabio, Christiano, Lawrence J., Roldos, Jorge
Format Journal Article
LanguageEnglish
Published Amsterdam Elsevier B.V 01.05.2009
Elsevier
Elsevier Sequoia S.A
SeriesJournal of Monetary Economics
Subjects
Collateral constraint
Collateral constraint Friedman rule Small open economy
Economic crisis
Friedman rule
Interest rate policy
Interest rates
Labor market
Monetary economics
Monetary policy
Open economies
Small open economy
Studies
Asia
E5
Collateral constraint
Small open economy
E44
Friedman rule
E4
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Summary:In the wake of the 1997–98 financial crises, interest rates in Asia were raised immediately, and then reduced sharply. We describe an environment in which this is the optimal monetary policy. The optimality of the immediate rise in the interest rate is an example of the theory of the second best: although high interest rates introduce an inefficiency wedge into the labor market, they are nevertheless welfare improving because they mitigate distortions due to binding collateral constraints. Over time, as the collateral constraint is less binding, the familiar Friedman forces dominate, and interest rates are optimally set as low as possible.
Bibliography:ObjectType-Article-2
SourceType-Scholarly Journals-1
ObjectType-Feature-1
content type line 23
ISSN:0304-3932
1873-1295
DOI:10.1016/j.jmoneco.2009.03.010