Optimal Credit, Monetary, and Fiscal Policy Under Occasional Financial Frictions and the Zero Lower Bound

I study optimal credit, monetary, and fiscal policy under commitment in a model where financial intermediaries face an occasionally binding financial constraint; the monetary authority faces a zero lower bound (ZLB); and the fiscal authority faces a budget constraint. Despite being inactive in the deterministic steady state, the credit policy is permanent in the risky steady state. Financial and productivity shocks can generate a tradeoff between inflation stability and financial stability, which is resolved in favour of the latter with the credit spread being virtually equal to zero under a reasonable calibration. As the ZLB prevents full-scale monetary easing when financial distress weighs on aggregate demand, monetary policy should be relatively tighter in normal times for a precautionary reason. Moreover, the optimal nominal interest rate is a bell-shaped function of productivity around the stochastic steady state, although it is sensitive to how much the central bank is constrained by its past commitments. Notwithstanding the mentioned policy tradeoff, the optimal Taylor type rule is strictly inflation targeting. However, the rule-based policy features too aggressive a credit intervention but insufficient monetary easing.