Financial Shocks and Optimal Policy

Harris Dellas (), Behzad Diba and Olivier Loisel

Working papers from Banque de France

Abstract: This paper incorporates banks as well as frictions in the market for bank capital into a standard New Keynesian model and considers the positive and normative implications of various financial shocks. It shows that the frictions matter significantly for the effects of the shocks and the properties of optimal monetary and fiscal policy. For instance, for shocks that increase banks' demand for liquidity, optimal monetary policy accepts an output contraction while it would not in the absence of the frictions (or under suitably conducted fiscal policy). We find that optimal monetary policy can be approximated by a simple interest-rate rule targeting inflation; and it also allows large adjustments in the money supply, a property reminiscent of Poole's analysis.

Keywords: Financial frictions; banking; optimal policy (search for similar items in EconPapers)
JEL-codes: E2 E4 (search for similar items in EconPapers)
Pages: 47 pages
Date: 2010
New Economics Papers: this item is included in nep-ban, nep-cba, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (11)

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Persistent link: https://EconPapers.repec.org/RePEc:bfr:banfra:277

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