Optimal monetary policy in a model of the credit channel

We consider a simple extension of the basic new-Keynesian setup in which we relaxthe assumption of frictionless financial markets. In our economy, asymmetricinformation and default risk lead banks to optimally charge a lending rate above therisk-free rate. Our contribution is threefold. First, we derive analytically theloglinearised equations which characterise aggregate dynamics in our model and showthat they nest those of the new- Keynesian model. A key difference is that marginalcosts increase not only with the output gap, but also with the credit spread and thenominal interest rate. Second, we find that financial...