A Dynamic General Equilibrium Analysis of Monetary Policy Rules, Adverse Selection and Long-Run Financial Risk

60 Pages Posted: 24 Nov 2011

See all articles by Hans J. Blommestein

Hans J. Blommestein

Vivid Economics; Organization for Economic Co-Operation and Development (OECD); Tilburg University - Tilburg University School of Economics and Management

Sylvester C. W. Eijffinger

Tilburg University (CentER) - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR)

Zongxin Qian

Renmin University of China - School of Finance

Date Written: November 2011

Abstract

This paper builds a dynamic general equilibrium macro-finance model with two types of borrowers: entrepreneurs who want to produce and gamblers who want to play a lottery. It links central bank's interest rate policy to expected cash flows of both types. This link enables us to study how the interactions between various shocks and different monetary policy rules affect the borrower pool faced by financial intermediaries. We find that when the economy is hit by an expansionary monetary policy shock, the proportion of entrepreneurs in the borrower pool will be persistently lower than the steady state level after a short period. It is lowest when the central bank does not react to output fluctuations. Quite differently, not reacting to output fluctuations avoids a persistent worsening of the borrower pool in the long run if the shock is a bad productivity shock.

Keywords: Adverse Selection, Financial Crisis, Monetary Policy

JEL Classification: E44, E52, G01

Suggested Citation

Blommestein, Hans J. and Eijffinger, Sylvester C. W. and Qian, Zongxin, A Dynamic General Equilibrium Analysis of Monetary Policy Rules, Adverse Selection and Long-Run Financial Risk (November 2011). CEPR Discussion Paper No. DP8652, Available at SSRN: https://ssrn.com/abstract=1964142

Hans J. Blommestein (Contact Author)

Vivid Economics

160 Euston Road
Grafton Place
London, NW1 2DX
United Kingdom

Organization for Economic Co-Operation and Development (OECD) ( email )

2 rue Andre Pascal
Paris Cedex 16, 75775
France

Tilburg University - Tilburg University School of Economics and Management ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Sylvester C. W. Eijffinger

Tilburg University (CentER) - Department of Economics ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 466 2411 (Phone)
+31 13 466 3042 (Fax)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.CESifo.de

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Zongxin Qian

Renmin University of China - School of Finance ( email )

Ming De Main Building 507B
Renmin University of China
Beijing, Beijing 100872
China

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
4
Abstract Views
528
PlumX Metrics