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Though the monetary policy transmission and financial intermediation literatures have respectively highlighted the role of the “bank credit channel” and relationship banking, the effect of relationship banking on the transmission of monitory policy has not been investigated. In this paper, we study the impact of relationship banking on the transmission of monitory policy. Theoretically, relationship banking could ameliorate or exacerbate the effects of monetary policy shocks. Using a sample of bank dependent firms in India, we find that firms that enjoy an exclusive banking relationship are less susceptible to monetary policy shocks than firms that engage in transactional banking. The effects are symmetric across monetary policy tightening and loosening. We conjecture that reduced information asymmetry due to relationship banking blunts the impact of “firm balance sheet channel” of monitory policy transmission.

Empirical evidence points to moderate inflation during stock market booms. To explain it and study optimal monetary policy in such a situation, this paper develops a dynamic model with rational bubbles and nominal rigidities. The model features a financial cost channel through which the shadow cost of borrowing affects the marginal cost. A bubble-led boom mitigates firms' borrowing constraints and keeps inflation from rising by decreasing the shadow cost of borrowing. In this situation Ramsey-optimal monetary policy calls for tightening to curb the boom. Strict inflation targeting is counterproductive in the short run as it exacerbates the boom. For obtaining these results the financial cost channel and nominal wage rigidity are essential.

The purpose of central bank minutes is to give an account of monetary policy meeting discussions to outside observers, thereby enabling them to draw informed conclusions about future policy. However, minutes are by necessity a shortened and edited representation of a broader discussion. Consequently, they may omit information that is predictive of future policy decisions. To investigate this, we compare the information content of the FOMC's minutes and transcripts, focusing on three dimensions which are likely to be excluded from the minutes: 1) the committee’s degree of hawkishness; 2) the chairperson’s degree of hawkishness; and 3) the level of agreement between committee members. We measure committee and chairperson hawkishness with a novel dictionary that is constructed using the FOMC’s minutes and transcripts. We measure agreement by performing deep transfer learning, a technique that involves training a deep learning model on one set of documents – U.S. congressional debates – and then making predictions on another: FOMC transcripts. Our findings suggest that transcripts are more informative than minutes and heightened committee agreement typically precedes policy rate increases.

This paper shows, using a three-country life-cycle model, that a contractionary U.S. monetary policy shock has weaker effects on output in an old country than in a young country. In response to the shock, despite a larger fall in consumption in the old country, investment there decreases by less and net exports rise by more, which enables output in the old country to decline by less. I then empirically show that the shock brings about a smaller fall in output and a greater rise in net exports in old countries using VARs, and that the shock leads to a larger fall in consumption and a smaller decrease in investment in old countries using the local projection method. The stronger incentives to save in the old country due to the longer life expectancy play a key role in generating these results.

We analyse empirically whether the common monetary policy of the Eurosystem has heterogeneous effects on the four large member countries of the European Monetary Union (France, Germany, Italy and Spain) focussing on possible cross-country differences in the reaction of output, the price level and financial variables to changes in the Euroystem’s monetary policy interest rate. We use a large multi-country Bayesian vector autoregression to jointly model the dynamics of output, prices and financial variables in the four countries after 1999. Following Giannone, Lenza, and Primiceri (2015) the prior distributions are selected in a data-driven way. We compare across countries the reactions of the variables to exogenous changes in the Eurosystem’s common monetary policy interest rate. The Bayesian approach specifically allows us to make explicit probabilistic statements about the extent of cross-country heterogeneity in the effects of monetary policy. We further strengthen the robustness our results using a battery of additional tests on cross-country differences in the distributions of the effects of monetary policy. Comparing the macroeconomic effects of an exogenous increase in the Eurosystem’s monetary policy interest rate across countries we find real output to respond less negatively in Spain compared to the other three countries while the drop in the price level is less pronounced in Germany relative to France, Italy and Spain. Bond yields rise more strongly and persistently in France and Germany compared to Italy and Spain.

I study an economy in which money and credit coexist as means of payment and the settlement of credit requires money. The model extends recent developments in microfounded monetary theory to address the choice of payment methods and the effects of inflation. Whether a buyer uses money or credit depends on the fixed cost of credit and the inflation rate.

In this paper, we investigate how negative interest rate policy (NIRP) introduced by the Bank of Japan (BoJ) affected Japanese banks' lending and risk-taking behavior. The BoJ's unexpected announcement was unequivocally viewed as an accommodative surprise in financial markets, but equity prices of Japanese financial firms experienced sharp drops. We exploit the cross-sectional variation in the change of share prices around the announcement to measure banks' differential exposure to negative rate policy. We first document the unique characteristics of Japan's banking system that heighten the exposure of Japanese banks to NIRP. We then show that, consistent with an operative risk taking channel, banks that were more exposed to NIRP insulated their profits from the adverse effects of negative policy rates by boosting risk-taking behavior and increasing credit supply relative to less exposed banks. However, our theoretical framework suggests that, for sufficiently negative rates, banks will eventually be pushed past the limit of their ability or willingness to offset profit pressures via additional risk taking, which can inhibit the transmission of NIRP through banks.

We consider the macroeconomic implications of the interaction between nominal rigidities and labor market frictions in a framework where firms jointly make pricing and hiring decisions. In our New Keynesian model, workers randomly search for jobs and are matched with firms that post take-it-or-leave-it contracts and are subject to sticky prices. Relative to the typical model that separates search frictions and nominal frictions into wholesale and retail firms, respectively, our model implies smoother wages because firms can affect their marginal costs by adjusting prices. A consequence of smoother wages is that the vacancy-to-unemployment ratio responds much more than under the standard model. Additionally, our baseline model shows larger effects of changing the inflation target and smaller effects of changing unemployment benefits. We also show that combining search and price frictions in one firm leads to less volatility after technology shocks but more volatility after monetary policy shocks.

We propose a monetary model with endogenous credit market participation to study the impact of financial inclusion on inequality and welfare. We find that consumption inequality results from differences in agents' decision to access financial services. This heterogeneity generates a pecuniary externality, potentially resulting in some agents over-consuming. Moreover, monetary policy has distributional consequences. To quantify these effects, we calibrate our model to India, accounting for a third of observed consumption inequality. Finally, we analyze various policies aimed at increasing financial inclusion and find that a direct transfer to bank account holders yields the highest welfare and lowest consumption inequality.

In a simple two-sector New Keynesian model, sticky prices generate a counterfactual negative comovement between the output of durable and nondurable goods following a monetary policy shock. We show that heterogeneous factor markets allow any combination of strictly positive price stickiness to generate positive output comovement.

What are the tradeoffs that the public is willing to accept between inflation and unemployment? We find that people dislike extra points of unemployment more than extra points of inflation. This is true for both Europe and Latin America. For the latter, the aversion to unemployment relative to inflation is much greater. Moreover, in both regions, the poor's distaste for extra points of unemployment relative to inflation is significantly greater than that of the rich. This result contributes to the literature on the costs of inflation and questions the commonly held view that prescribes strong anti‐inflationary postures as a way to implement policies consistent with the preferences of the poor.

Countries that specialize in commodity exports often exhibit a correlation between the relevant commodity price and the value of their currency. We explore an explanation for this correlation based on the present‐value, monetary model of the exchange rate. An increase in the commodity price leads to an increase in the expected, future policy interest rate and so to an immediate appreciation. We test the model's over‐identifying restrictions for Canada, Australia, and New Zealand. There, controlling for the effect of commodity prices in predicting current and future monetary policy leaves those prices no significant, remaining role in statistically explaining exchange rates.

We provide quantitative guidance on whether and to what extent different elements of Heterogeneous Agent New Keynesian (HANK) models amplify or dampen the response of aggregate consumption to a monetary policy shock. We emphasize four findings. First, the introduction of capital adjustment costs does not affect the aggregate response, but does change the transmission mechanism so that a larger share of indirect effects originates from equity prices rather than from labor income. Second, incorporating estimated unequal incidence functions for aggregate labor income fluctuations leads to either amplification or dampening, depending on the data and estimation methods. Third, distribution rules for monopoly profits that allocate a larger share to liquid assets lead to greater amplification. Fourth, assumptions about the fiscal reaction to a monetary policy shock have a stronger effect on the aggregate consumption response than any of the other three elements.

The unconventional monetary policy of forward guidance operates through the management of expectations about future paths of interest rates. This paper examines the link between expectations formation and the effectiveness of forward guidance. A standard New Keynesian model is extended to include forward guidance shocks in the monetary policy rule. Agents form expectations about future macroeconomic variables via either the standard rational expectations hypothesis or a more plausible theory of expectations formation called adaptive learning. The results show the efficacy of forward guidance depends on the manner in which agents form their expectations. In response to forward guidance, the paths of the output gap and inflation under adaptive learning overshoot and undershoot those implied by rational expectations. The adaptive learning impulse responses of the endogenous variables to a forward guidance shock exhibit more persistence before and after the forward guidance shock has been realized upon the economy. During an economic crisis (e.g. a recession), the assumption of rational expectations overstates the effects of forward guidance relative to adaptive learning. Specifically, the output gap is higher under rational expectations than adaptive learning. Thus, if monetary policy is based on a model with rational expectations, which is the standard assumption in the macroeconomic literature, the results of forward guidance could be potentially misleading.

We study the implications of multiperiod mortgage loans for monetary policy, considering several realistic modifications—fixed interest rate contracts, a lower bound constraint on newly granted loans, and the possibility of the collateral constraint to become slack—to an otherwise standard DSGE model with housing and financial intermediaries. We estimate the model in its nonlinear form and argue that all these features are important to understand the evolution of mortgage debt during the recent US housing market boom and bust. We show how the nonlinearities associated with the two constraints make the transmission of monetary policy dependent on the housing cycle, with weaker effects observed when house prices are high or start falling sharply. We also find that higher average loan duration makes monetary policy less effective and may lead to asymmetric responses to positive and negative monetary shocks.

This paper examines a search model of money and public bonds in which coordination frictions lead to multiple, Pareto ranked equilibria. Whether money and bonds are substitutes or complements, is not a primitive of the economy, but an equilibrium outcome. There exists an equilibrium resembling a liquidity trap, in which money and bonds are perfect substitutes, interest rates are zero, and monetary policy is ineffective; and a superior equilibrium in which money and bonds are complements, interest rates are positive and monetary policy has a liquidity effect. On this view, the liquidity trap is a belief-driven phenomenon.

We study the welfare effects of international monetary policy spillovers at the zero lower bound, focusing on the effects of forward guidance in a large economy (“foreign”) on its smaller trading partner (“home”) in scenarios motivated by the global financial crisis. We find that foreign forward guidance has an overall prosper‐thy‐neighbor effect on the home economy as long as it increases foreign welfare. This finding holds under alternative assumptions about exchange rate pass‐through or the degree of international financial integration. However, foreign forward guidance may worsen the trade‐off between the stabilization objectives of home monetary policy.

We pursue an empirical strategy to identify a monetary news shock in the U.S. economy. We use a monetary policy residual, along with other variables in a vector autoregression (VAR), and identify a monetary news shock as the linear combination of reduced-form innovations that is orthogonal to the current residual and that maximizes the sum of contributions to its forecast error variance over a finite horizon. Real GDP declines in a persistent manner after a positive monetary news shock. This contraction in economic activity is accompanied by a fall in inflation and a rapid increase in the nominal interest rate.

We study optimal monetary policy in a New Keynesian model in which the monetary authority faces a trade-off between inflation and output-gap stabilization due to cost-push shocks. In particular, we highlight the role of the inflation target adjustment in stabilization policy by showing that it can mitigate this policy trade-off and considerably improve welfare. The main findings can be summarized as follows. First, we find that the welfare cost of a standard Taylor rule is non-trivial, even with optimized policy coefficients. Second, we propose an additional policy tool of a medium-run inflation target (MRIT) rule. When combined with the standard Taylor rule, the optimal MRIT significantly reduces fluctuations in inflation originating from the cost-push shocks and results in a similar level of welfare to that associated with the Ramsey optimal policy. Third, the optimal MRIT needs to be adjusted in a persistent manner and in the opposite direction to the realization of a cost-push shock. Fourth, the welfare implication of the MRIT is more pronounced under a flatter Phillips curve. Finally, the main findings are relevant to the current economic environment of low inflation rates under a flat Phillips curve, implying that the monetary authority should increase the inflation target in such an environment.

We investigate the effects of banks’ operating costs on allocations and welfare in a low interest rate environment. We introduce an explicit production function for banks in a microfounded model where banks employ labor resources, hired on a competitive market, to run their operations. In equilibrium, this generates a spread between interest rates on loans and deposits, which reflects the underlying monetary policy and the efficiency of financial intermediation. In a deflation or low-inflation environment, equilibrium deposits yield zero returns. Hence, banks soak up labor resources to offer deposits that do not outperform idle balances, thus reducing aggregate efficiency.

This paper constructs a two‐country core–periphery New Keynesian model of a currency union to address the interaction between the objectives of regionally directed fiscal policy constrained by a single currency and the aggregate use of fiscal policy in face of the zero lower bound (ZLB) on policy interest rates. We identify an optimal path of aggregate and relative fiscal policy responses to a negative region‐specific demand shock. Our results show that (i) in a monetary union, the optimal policy response to an asymmetric reduction in demand concentrated in the periphery always entails a relative shift of fiscal expenditure toward the worse‐affected regions, (ii) though no aggregate fiscal response is required outside the ZLB, and (iii) optimal union‐wide fiscal policy is expansionary at the ZLB. Therefore, optimal policy always entails an expansion in the periphery at the ZLB, but the optimal fiscal response in the core regions can be either expansionary or contractionary depending on the parameters of the model. However, (iv) fiscal expansion in the core is warranted if the periphery cannot implement an expansion due to constraints on public spending.

The real eective exchange rate (REER) is one of the most cited statistical constructs in open-economy macroeconomics. The conventional measures of the REER assume a world in which every country exports only final goods. With rising importance of oshoring and cross-border trade in intermediate goods, such measures are increasingly flawed. Taking into account international value chains, we develop a theoretical framework to compute REER at the both sector and country levels. The framework nests all existing measures in the literature and addresses their shortcomings. We exploit detailed trade data from the recently available World Input-Output Database(WIOD) spanning the period 1995-2011 to compute the REER for gross output as well as value added for 40 countries and 1435 country-sectors.

We estimate the response of sovereign bond prices to net supply shocks caused by purchase operations under the ECB's Public Sector Purchase Programme (PSPP). To avoid simultaneity bias in the estimated relationship between prices and purchases, we exploit a PSPP feature that renders securities temporarily ineligible for reasons unrelated to their prices. Using these purchase restrictions as an instrument to identify exogenous variation in purchase volumes, we find that PSPP causes statistically significant and economically relevant upward price impacts. The impacts are short‐lived and concentrated in securities issued by higher yield jurisdictions and characterized by higher maturity and lower liquidity.

This paper uses high-frequency financial data to analyze the effects of US monetary policy—during the conventional and unconventional policy regimes—on international bonds markets. We focus on yields of dollar-denominated sovereign bonds issued by more than 90 countries since the early 1990s, which allows us to abstract from the policy-induced movements in exchange rates that otherwise confound the response of yields on foreign bonds denominated in local currencies. Our results show that yields on dollar-denominated sovereign debt are highly responsive to unanticipated changes in the stance of US monetary policy during both the conventional and unconventional policy regimes, and that the passthrough of unconventional policy actions to foreign bond yields is, on balance, comparable to that of conventional policy actions. In addition, a conventional US monetary easing leads to a significant narrowing of credit spreads on sovereign bonds issued by countries with a speculative-grade credit rating. During the unconventional policy regime, however, yields on speculative-grade sovereign debt move one-to-one with policy-induced fluctuations in yields on comparable US Treasuries. We also examine whether the response of sovereign credit spreads to US monetary policy differs between policy easings and policy tightenings and find no evidence of such asymmetry. This finding casts doubt on the notion that US monetary easings induce excessive risk-taking in international bond markets.

In this paper, we analyze the use of macroprudential policies in a low interest rate environment, where an occasionally binding zero lower bound (ZLB) constraint gives rise to aggregate demand externalities. We study this issue by using a dynamic stochastic general equilibrium (DSGE) model with financial frictions and a monetary policy rule that is subject to the ZLB. We find that, in a low interest rate environment, the occasionally binding ZLB creates additional scope for macroprudential intervention. When the interest rate is high and the two policies can perfectly coordinate, the optimal policy prescriptions behave as if they were independent. This is, however, no more the case, when the interest rate is low and/or when monetary policy and macroprudential policy cannot be perfectly coordinating. This more complex policy environment calls for more policy coordination.

This paper examines the effect of monetary policy on the liquidity premium, i.e., the market value of the liquidity services that financial assets provide. To guide the empirical analysis, I set up a monetary search model in which bonds provide liquidity services in addition to money. The theory predicts that money supply and the nominal interest rate are positively correlated with the liquidity premium, but the latter is negatively correlated with the bond supply. The empirical analysis over the period from 1946 and 2008 confirms the theoretical findings. This indicates that liquid bonds are substantive substitutes for money and the opportunity cost of holding money plays a key role in asset price determination. The model can rationalize the existence of negative nominal yields, when the nominal interest rate is low and liquid bond supply decreases.

Speed limit policy, a monetary policy strategy that focuses on stabilizing inflation and the change in the output gap, consistently delivers better welfare outcomes than flexible inflation targeting or flexible price level targeting in empirical New Keynesian models when policymakers lack the ability to commit to future policies. Even if the policymaker can commit under an inflation targeting strategy, the discretionary speed limit policy performs better for most empirically plausible model parameterizations from a normative perspective.

This paper provides robust evidence for the nonlinear effects of mortgage spread shocks during recessions and expansions in the United States. Estimating a smooth‐transition vector autoregression (STVAR) model, we show that mortgage spread shocks hitting in a recessionary phase create significantly deeper and more protracted declines in consumption and housing market variables. In addition, we provide evidence that these mortgage spread shocks could be largely interpreted as credit supply shocks in the mortgage market. Our empirical results imply that unconventional monetary policy, such as the Federal Reserve's mortgage‐backed security purchase program, would be a more effective tool for stabilizing the economy during recessions than in expansions.

We study the real long‐run effects of the structural stance of monetary policy and of inflation, in the context of a monetary growth model where R&D is complemented with physical capital accumulation. We look into the effects on a set of real macroeconomic variables that have been of interest to policymakers—the economic growth rate, real interest rate, physical investment rate, capital‐to‐labor ratio, R&D intensity, and velocity of money. These variables have been previously analyzed from the perspective of different, separated, strands of the theoretical and empirical literature. Additionally, we analyze the long‐run relationship between inflation and both the effectiveness of real industrial‐policy shocks and the market structure, assessed namely by average firm size. We present novel cross‐country evidence on the empirical relationship between the latter and long‐run inflation.

We quantify the macroeconomic effects of the European Central Bank's unconventional monetary policies using a dynamic stochastic general equilibrium model which includes a set of shadow interest rates. Extracted from the yield curve, these shadow rates provide unconstrained measures of the overall stance of monetary policy. Counterfactual analyses show that, without unconventional measures, the euro area would have suffered (i) a substantial loss of output since the Great Recession and (ii) a period of deflation from mid‐2015 to early 2017. Specifically, year‐on‐year inflation and GDP growth would have been on average about 0.61% and 1.09% below their actual levels over the period 2014Q1–17Q2, respectively.

Shadow short rate (SSR) estimates are generated regressors proposed as a proxy for policy interest rates during unconventional monetary policy (UMP) periods. However, using the Wu and Xia (2016) shadow/lower‐bound model, I show that SSR estimates can be sensitive to minor choices in their estimation. Used subsequently in a small macroeconomic model, those sensitivities lead to wide variations in the inferred effects of UMP on inflation and unemployment outcomes. Therefore, it should not be presumed that any SSR series will necessarily be quantitatively useful. Vetting SSR series allows appropriate SSR series to be retained within the suite of UMP indicators.

Monetary policy implementation could, in theory, be constrained by deeply negative rates since overnight market participants may have an incentive to invest in cash rather than lend to other participants.

This paper shows how interbank market fragmentation disrupts the transmission of monetary policy. Fragmentation is the fact that banks, depending on their country of location, have different probabilities of default on their interbank borrowings. Once fragmentation is introduced into standard theoretical models of monetary policy implementation, excess liquidity arises endogenously. This leads short‐term interest rates to depart from the central bank policy rates. Using data on monetary policy operations, I show that this mechanism has been at work in the euro area since 2008. The model is used to analyze conventional and unconventional monetary policy measures.

We examine how cross‐firm and cross‐country heterogeneity shapes the responses of corporate investment in emerging markets to changes in U.S. monetary policy and financial‐market volatility, the latter proxying for uncertainty. We find that in response to increases in U.S monetary policy rates or financial‐market volatility, financially weaker firms reduce investment by more than financially strong firms. We also show that firms with stronger balance sheets delay investment voluntarily when faced with higher uncertainty. Finally, we find that stronger macroeconomic fundamentals (lower public debt or higher international reserves) help to buffer corporate investment from increases in U.S. monetary policy rates.

We study optimal monetary policy in a New‐Keynesian Dynamic Stochastic General Equilibrium (DSGE) model with a credit channel and relationship lending in banking. We show that borrowers' bank‐specific (deep) habits give rise to countercyclical credit spreads, which, in turn, make optimal monetary policy depart substantially from price stability, under both discretion and commitment. Our analysis shows that the welfare costs of setting monetary policy under discretion (with respect to the optimal Ramsey plan) and of using simpler suboptimal policy rules are strictly increasing in the magnitude of deep habits in credit markets and market power in banking.

We estimate a logit mixture vector autoregressive model describing monetary policy transmission in the euro area over the period 1999–2015. In contrast to other classes of nonlinear vector autoregressive models, regime affiliation is neither strictly binary, nor binary with a transition period, and based on multiple variables. We show that monetary policy transmission in the euro area can be described as a mixture of two states. In both states, output and prices are found to decrease after contractionary monetary policy shocks. However, the effects of monetary policy are less enduring in the “crisis state.”

We study the impact of the announcement of the European Central Bank's (ECB's) Outright Monetary Transactions Program on small firms’ access to finance using a matched firm‐bank data set from eight Eurozone countries. We find that following the announcement, credit access improved relatively more for firms borrowing from banks with high balance sheet exposures to impaired sovereign debt, with such firms less likely to be refused a loan or to be price rationed. Loan terms also improved as manifested by lengthening of loan maturities. Unconventional monetary policy has a positive impact on firms’ investment and profitability, while its effect on firm innovation is weaker.

This paper evaluates the implications of search and matching frictions in the financial market for the bank lending channel of monetary policy. Borrowers and lenders participate in a decentralized loan market for the purpose of establishing long‐term credit relationships and the provision of loanable funds to productive firms. Locating credit relationships is costly in terms of time and real resources and the interest rate is negotiated via a bargaining mechanism. This structure is incorporated into an otherwise standard monetary business cycle framework and used to study how such frictions in the credit market contribute to explaining the contemporaneous impact and propagation of monetary growth shocks and inflation. While anticipated inflation negatively impacts real activity, it can also increase loan market participation and the inflow of newly established credit relationships. It is shown that (i) bargaining and costly search mitigates the traditional inflation tax effect of monetary injections and (ii) the existence of long‐term lending relations tends to dampen liquidity effects. Monetary shocks in this environment lead to larger liquidity effects relative to the frictionless case and are capable of generating persistence in the nominal interest rate, labor, consumption, and output. It can also explain the excess volatility of credit creation relative to output and the observation that overall credit creation can lead output over the business cycle.

The literature on the risk‐taking channel of monetary policy grew quickly, leading to scattered evidence. We examine this channel through different angles, exploring detailed information on loan origination and performance. Ex ante riskier borrowers receive more funding at the extensive margin when interest rates are lower. Ex post performance is independent of the level of interest rates at origination. Still, loans granted in periods of very low and stable interest rates show higher default rates once interest rates start to increase. Risk‐taking is stronger among banks with lower capital ratios, suggesting that this channel may be linked to managerial incentives for risk‐shifting.

How do intellectual property rights that determine the market power of firms influence the effects of monetary policy on economic growth and social welfare? To analyze this question, we develop a monetary R&D-based growth model with elastic labor supply. We find that monetary expansion reduces growth and welfare through a decrease in labor supply that reduces R&D. Furthermore, a larger market power of firms strengthens these effects of monetary policy in the R&D model. In contrast, increasing the market power of firms dampens the growth and welfare effects of monetary policy in the AK model. Therefore, the market power of firms has drastically different implications on the welfare cost of inflation under the two growth engines (i.e., innovation versus capital accumulation). We also calibrate the two models using data in the US and the Euro Area to quantitatively evaluate and compare the welfare cost of inflation in the two economies. Finally, we simulate transition dynamics of the R&D model in order to compute the complete welfare changes from reducing inflation.

We investigate how the level of household indebtedness affects the monetary transmission mechanism in the U.S. economy. Using state‐dependent local projection methods, we find that the effects of monetary policy are less powerful during periods of high household debt. In particular, the impact of monetary policy shocks is smaller on GDP, consumption, residential investment, house prices, and household debt during a high‐debt state. We then build a partial equilibrium model of borrower households with financial constraints to rationalize these facts. The model points to the weakening of the home equity loan channel as a possible reason for the decline in monetary policy effectiveness when initial debt levels are high.

I investigate the nonlinear effects of monetary policy through differences in household debt across U.S. states. After constructing a novel indicator of inflation for the states, I compute state-specific monetary policy stances as deviations from an aggregate Taylor rule. I find that the effectiveness of monetary policy is curtailed during periods of large household debt imbalances. Moreover, a common U.S. monetary policy does not fit all; it may have asymmetric effects on the economic performance across states, particularly at times of high dispersion in the household debt imbalances, as it may have been the case around the Great Recession.

I analyze a New Keynesian dynamic stochastic general equilibrium (DSGE) model where the financing of productive investment is affected by a moral hazard problem. I solve for jointly Ramsey‐optimal monetary and macroprudential policies. I find that when a financial friction is present in addition to the standard nominal friction, the optimal policy can replicate the first‐best allocation if the social planner can conduct both monetary and macroprudential policy. Using monetary policy alone is not enough: a policy trade‐off between stabilizing inflation and output gap emerges. When policy follows simple rules, the source of fluctuations is relevant for the choice of the appropriate policy mix.

Central banks may face challenges in achieving their price stability goals when financial stability risks are present. There is, however, considerable heterogeneity among central banks with respect to how they manage these potential trade-offs.