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Credit Market Distortions, Asset Prices And Monetary Policy

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Executive Summary

In this paper the authors develop a sticky price DSGE model to study the role of capital market imperfections for monetary policy implementation. Recent empirical and theoretical studies have stressed the effect of firms' external finance on their pricing decisions. The so-called cost channel of the transmission mechanism has been explored within New Keynesian frameworks that pose particular emphasis on inflation dynamics. These models generally disregard the role of external finance for the dynamics of asset prices. They ask whether monetary policy should respond to deviations of asset prices from their frictionless level and, more importantly, if the answer to this question changes when financial frictions are properly taken into account.

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