How should monetary and fiscal policy react to adverse financial shocks? If monetary policy is constrained by the zero lower bound on the nominal interest rate, subsidising the interest rate on loans is the optimal policy. The subsidies can mimic movements in the interest rate and can therefore...

Central banks can go broke and have done so, although mainly in developing countries. The conventional balance sheet of the central bank is uninformative about the financial resources it has at its disposal and about its ability to act as an effective lender of last resort and market marker of...

Financial markets are incomplete, thus for many households borrowing is possible only by accepting a financial contract that specifies a fixed repayment. However, the future income that will repay this debt is uncertain, so risk can be inefficiently distributed. This paper argues that a monetary...

We study a model with repeated moral hazard where financial contracts are not fully indexed to inflation because nominal prices are observed with delay as in Jovanovic and Ueda 1997. More constrained firms sign contracts that are less indexed to inflation and, as a result, their investment is...

We examine global dynamics under infinite-horizon learning in New Keynesian models where monetary policy practices either price-level or nominal GDP targeting and compare these regimes to inflation targeting. These interest-rate rules are subject to the zero lower bound. Robustness of the three...

Blanchard (2005) suggested that active interest rate policy might induce unstable dynamics in highly-indebted economies. We examine this in a dynamic general equilibrium model where Calvo-type price rigidities provide a rationale for inflation stabilization. Unstable dynamics can occur when the...

The paper establishes that sovereigns, like banks, need a lender of last resort (LoLR). In the euro area the ECB, with its estimated €3.4 trillion non-inflationary loss absorption capacity, is the only credible sovereign LoLR. The ECB/Eurosystem has been acting as sovereign LoLR through its...

In this Paper, we analyse the implications of price setting restrictions for the conduct of cyclical fiscal and monetary policy. We consider an environment with monopolistic competitive firms, a shopping time technology, prices set one period in advance, and government expenditures that must be...

The Paper provides a formalization of the monetary economics folk proposition that government fiat money is an asset of the holder (the private sector) but not a liability of the issuer (the state). Money is 'net wealth' in the limited sense that, after consolidation of the intertemporal budget...

While high uncertainty is an inherent implication of entering the zero lower bound, deflation is not, because agents are likely to be uncertain about the way policy makers will deal with the large stock of debt arising from a severe recession. We draw this conclusion based on a standard...