MONETARY POLICY AND CREDIT MARKET IMPERFECTION

Abstract

Credit market imperfection prevents the economy from attaining its full potential. This paper examines the change in monetary policy in presence of this imperfection. Using the Corsetti-Pesenti model, this study shows that when credit market is not needed or perfect, monetary policy should respond fully to productivity shock. However, when credit market is in need but imperfect, the extent to which monetary policy responds to productivity shock should depend on the degree of credit market imperfection. The less perfect the credit market, the less the response. This study also shows that credit market imperfection might not be sustainable, which calls for government interventions.