SMOOTHED INTEREST RATE SETTING BY CENTRAL BANKS AND STAGGERED LOAN CONTRACTS

I investigate a new source of economic stickiness: namely, staggered loan interest rate contracts under monopolistic competition. This study introduces this mechanism into a standard new Keynesian model. Simulations show that a response to a financial shock is greatly amplified by the staggered loan contracts, although a response to a productivity, cost-push or monetary policy shock is not much affected. I derive an approximated loss function and analyse optimal monetary policy. Unlike other models, the function includes a quadratic loss of the first-order difference in loan rates. Thus, central banks have an incentive to smooth the policy rate.