Credit expansion in a monetary policy game: Implications of the valuation haircut framework

Abstract

In this study, we build on the traditional monetary policy game framework of institutional design to formalize the linkage among credit expansion, inflation expectations, and inflation. We show that the optimal monetary response of the central bank implies an optimal level of credit expansion that minimizes central bank losses. Moreover, central bank conservativeness may affect the optimal level of credit expansion. Assuming that credit expansion is a function that captures the effect of the valuation haircut framework of the central bank, we offer some insights into the complexity of interactions and the possible effects on the real economy.