DP9989 Credit Spreads and Credit Policies

Author(s): Isabel Correia, Fiorella De Fiore, Pedro Teles, Oreste Tristani
Publication Date: May 2014
Keyword(s): banks, credit policies, credit subsidies, monetary policy, zero bound on interest rates
JEL(s): E31, E40, E44, E52, E58, E62, E63
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=9989

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 overcome the zero bound restriction. Credit subsidies are optimal irrespective of how they are financed. If debt is not state contingent, they result in a permanent increase in the level of public debt and future taxes, and in a permanent reduction in output.