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Volume 61, Issue 6

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Monetary Policy Rules with Financial Instability

Bauducco , Sofía; Bulíř, Aleš; Čihák, Martin

Year: 2011   Volume: 61   Issue: 6   Pages: 545-565

Abstract: To provide a rigorous analysis of monetary policy in the face of financial instability, the authors extend the standard dynamic stochastic general equilibrium model to include a financial system. Their simulations suggest that if financial stability affects output and inflation with a lag, and if the central bank has privileged information about financial stability, then monetary policy responding instantly to deteriorating financial stability can trade off more output and inflation instability today for a faster return to the trend than a policy that follows the traditional Taylor rule. This augmented rule leads in some parameterizations to improved outcomes in terms of long-term welfare, but the welfare impacts of such a rule are small.

JEL classification: E52, E58, G21

Keywords: DSGE models, financial instability, monetary policy rule

RePEc: http://ideas.repec.org/a/fau/fauart/v61y2011i6p545-565.html

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