Unformatted text preview: r the policy rate should be adjusted as necessary in order for its projections
of inflation and real activity to satisfy a quantitative target criterion—will automatically
cally incorporate responses to changes in financial conditions to the extent that
these shift the IS curve, as in the model sketched above. In addition, this alternative
approach has the advantage of not requiring the central bank to focus on a single
interest rate spread when multiple aspects of financial conditions are each relevant
to aggregate demand and supply determination.
“Unconventional” Monetary Policies
The model also implies that traditional interest-rate policy alone will not, in
general, provide a fully adequate response to a disturbance to credit supply, no
matter how large the cut in the policy rate that may be engineered. The reason is
that even if a sufficient reduction in the policy rate can offset the decline in aggregate
gate demand that would otherwise result from the shift in the IS curve, this does not
fully undo the distortions created by the increase in credit spreads. To the extent
that savers would be willing to supply addit...
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