A model of state-dependent monetary policy

In the presence of occasionally binding borrowing constraints, the responses of output to monetary policy shocks depend on the Euler equation of unconstrained households. Conversely, the set of unconstrained households depends on the responses of output. I show analytically that this equilibrium interaction creates state-dependent and asymmetric output responses. When stockholders’ incomes are more pro-cyclical than non-stockholders’, output responds less to monetary policy in recessions, and contractionary monetary policy is more powerful than expansionary policy. These results are consistent with the empirical evidence.