The Simple Analytics of Monetary Policy: A Post-Crisis Approach

Benjamin M. Friedman

NBER Working Paper No. 18960
Issued in April 2013
NBER Program(s):Monetary Economics

The standard workhorse models of monetary policy now commonly in use, both for teaching macroeconomics to students and for supporting policymaking within many central banks, are incapable of incorporating the most widely accepted accounts of how the 2007-9 financial crisis occurred and incapable too of analyzing the actions that monetary policymakers took in response to it. They also offer no point of entry for the frontier research that many economists have subsequently undertaken, especially research revolving around frictions in financial intermediation. This paper suggests a simple model that bridges this gap by distinguishing the interest rate that the central bank sets from the interest rate that matters for the spending decisions of households and firms. One version of this model adds to the canonical "new Keynesian" model a fourth equation representing the spread between these two interest rates. An alternate version replaces this reduced-form expression for the spread with explicit supply and demand equations for privately issued credit obligations. The discussion illustrates the use of both versions of the model for analyzing the kind of breakdown in financial intermediation that triggered the 2007-9 crisis, as well as "unconventional" central bank actions like large-scale asset purchases and forward guidance on the policy interest rate.

download in pdf format
   (221 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w18960

Published: Benjamin M. Friedman, 2013. "The Simple Analytics of Monetary Policy: A Post-Crisis Approach," The Journal of Economic Education, vol 44(4), pages 311-328.

Users who downloaded this paper also downloaded* these:
Bruno and Shin w18942 Capital Flows and the Risk-Taking Channel of Monetary Policy
GalĂ­ w18806 Monetary Policy and Rational Asset Price Bubbles
Friedman w8057 Monetary Policy
Aizenman, Jinjarak, and Park w18963 Fundamentals and Sovereign Risk of Emerging Markets
Friedman and Kuttner w16165 Implementation of Monetary Policy: How Do Central Banks Set Interest Rates?
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us