Monetary Rules, Financial Stability and Welfare in a non-Ricardian Framework

Adame Espinosa Francisco

No 2023-14, Working Papers from Banco de México

Abstract: This work is based on a new Keynesian theoretical model for an advanced economy, which incorporates overlapping generations to analyze a channel through which fluctuations in household financial wealth influence aggregate demand. The optimal monetary policy, corresponding to that of a central planner maximizing households' welfare, aims to mitigate financial fluctuations while simultaneously reducing variability in inflation and the output gap. The model is calibrated for the United States and reproduces the effect of variations in the price of financial assets on aggregate demand. The results show, first, that in the presence of productivity, financial, and demand shocks, optimal monetary policy significantly improves aggregate welfare by stabilizing financial fluctuations that impact households' wealth. Secondly, in the face of productivity and financial shocks, an augmented monetary rule responding explicitly to fluctuations in the price of financial assets, in addition to inflation and output gaps, can reproduce the welfare achieved under optimal monetary policy. However, this is not the case for demand shocks.

Keywords: Monetary Policy; Monetary Rules; Overlapping Generations (search for similar items in EconPapers)
JEL-codes: E21 E44 E52 E58 (search for similar items in EconPapers)
Date: 2023-11
New Economics Papers: this item is included in nep-ban, nep-cba, nep-dge, nep-fdg, nep-inv, nep-mac and nep-mon
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