Abstract: What are the channels through which monetary policy affects financial stability? Can (and should) central banks prevent financial crises by tolerating higher inflation volatility? To what extent may monetary policy itself brew financial fragility? We study these questions through the lens of a textbook New Keynesian model augmented with capital accumulation and endogenous financial crises due to adverse selection in credit markets. Our main findings are threefold. First, monetary policy affects the probability of a crisis not only in the short–term (through its usual effects on aggregate demand) but also over the medium–term (through its effects on capital accumulation). Second, the central bank can significantly reduce the incidence of financial crises in the medium–term by tolerating higher inflation volatility in the short–term. Third, financial crises tend to occur in the wake of a protracted dis–inflationary boom —possibly combined with loose monetary policy, as the central bank reverses course and hikes its policy rate.

Keywords: inflation targeting, low–for–long policy rate, adverse selection, financial crises

Abstract: We study how Big Tech’s entry into finance may affect the credit channel of monetary policy. Our empirical analysis suggests that big tech credit and bank credit react very differently to monetary policy. We rationalize these findings through the lens of a new framework where Big Techs facilitate matching in the supply chain and extend working capital loans, thus adding an additional source of finance relative to bank loans. The Big Tech firm reinforces credit repayment with the threat of exclusion from its ecosystem, while bank credit is secured against collateral. According to our model: (i) big tech credit reacts less to monetary policy due to a more muted response of firms’ profits as opposed to physical collateral; (ii) as matching efficiency on Big Tech’s commerce platform rises, the expansion in firms’ profits leads to a higher share of big tech credit, and hence, to weaker responses of credit and output to monetary policy.

Keywords: Big Techs, monetary policy, credit frictions

Abstract: Literature so far has studied the transmission and optimal design of monetary policy in setups with either only financially-unconstrained firms or with only financially-constrained firms. This paper analyses these questions in an extension of the basic New Keynesian model with both types of firms, and yields a number of novel theoretical insights. (i) The interactions of the two types of firms on input and output markets activate a new transmission channel (the “spillover channel”). Because of this new channel, (ii) aggregate output does not necessarily respond more strongly t monetary policy, and (iii) the optimal design of monetary policy does not necessarily change when the share of constrained firms is higher (contrary to the financial accelerator intuition). The model is used to discuss the responses to monetary policy of financially constrained and unconstrained firms in the UK.

Keywords: New Keynesian model, financially-constrained firms, firm heterogeneity, workingcapital credit, monetary policy transmission, optimal monetary policy

Abstract: With their aging populations, many advanced economies are currently (i) facing a decline in their long-run interest rates, and (ii) a strong increase in their social security deficit. The former increases the probability that the policy rate is constrained by the zero lower bound (ZLB). The latter increases the probability that the fiscal limit (FL) is reached. In this paper, we study the optimal monetary-fiscal policy under both constraints. We conduct our analysis in an extension of the basic New Keynesian model with an endogenous fiscal limit. We assume away both outright default on public debt and outright monetary financing. Two of the main insights are: (i) In response to negative demand shocks, as the economy approaches FL, the reduction in fiscal space limits the future boom that the policymaker can promise at the ZLB. Subsequently, dynamics become less inflationary, output is less stabilized in a liquidity trap, and welfare losses increase significantly. (ii) Positive technology shocks temporarily shift the Laffer curve upwards, and, relatively to demand shocks, allow the policymaker to attain a better welfare outcome at the ZLB in the proximity of the FL.

Keywords: Monetary policy, fiscal policy, endogenous fiscal limit, ZLB

Abstract: The textbook New Keynesian framework has become a common tool for monetary policy analysis in central banks. Policymakers are nonetheless often concerned that this framework abstracts away from endogenous money creation, and lacks realism. To address this concern, I introduce endogenous money creation by the private banking sector (like deposits), or “inside money”, into the textbook framework. I find that the new “inside money” model has the same equilibrium representation as the textbook “money-less” one, and hence transmission and optimal design of monetary policy in the two models are identical.

Keywords: New Keynesian model, inside-money, cashless, inside-liquidity banking theory

The ratio of intangible to tangible capital ratio in advanced economies has been raising steadily over the past decades. We study whether/how this trend affects the transmission of monetary policy. Using firm- level data, we find that on average firms with a lower ratio of tangible capital (eg more R&D), respond more to monetary policy, and are less levered. We explain this result by the fact that intangible capital being less pledgeable than physical capital| these firms are relatively more financially constrained. We use a theoretical model to rationalize these results and to study the implications for monetary policy design.