Adjusting interest rates based on credit spreads can enhance economic stability.
The article explores adjusting interest rate policies to account for changes in financial conditions, specifically credit spreads. By using a model with credit frictions, the researchers found that incorporating adjustments for credit spreads can enhance the standard interest rate policy. However, the effectiveness of the adjustment depends on the source of the credit spread variation. Responding to changes in the quantity of credit may not be as beneficial as adjusting for credit spreads.