Monetary policy and financial stability in the long run

Jin Cao () and Loran Chollete
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Loran Chollete: UiS Business School, Norway

No 2013/21, Working Paper from Norges Bank

Abstract: Most theoretical central bank models use short horizons and focus on a single tradeoff. However, in reality, central banks play complex, long-horizon games and face more than one tradeoff. We account for these issues in a simple infinite-horizon game with a novel tradeoff: higher rates deter financial imbalances, but lower rates reduce the likelihood ofinsolvency. We term these factors discipline and stability effects, respectively. The centralbank's welfare decreases with dependence between real and financial shocks, so it may reduce costs with correlation-indexed securities. In our model, independent central banks cannot in general attain both low inflation and financial stability.

Keywords: Central Bank; Correlation-indexed security; Discipline effect; Stability effect (search for similar items in EconPapers)
JEL-codes: E50 G21 G28 (search for similar items in EconPapers)
Pages: 41 pages
Date: 2013-08-22
New Economics Papers: this item is included in nep-ban, nep-cba, nep-mac and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:bno:worpap:2013_21

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