Time-Varying Monetary-Policy Rules and Financial Stress: Does Financial Instability Matter for Monetary Policy?

Jaromir Baxa, Roman Horvath and Bořek Vašíček ()

Working Papers from Czech National Bank, Research and Statistics Department

Abstract: We examine whether and how selected central banks responded to episodes of financial stress over the last three decades. We employ a new monetary-policy rule estimation methodology which allows for time-varying response coefficients and corrects for endogeneity. This flexible framework applied to the USA, the UK, Australia, Canada, and Sweden, together with a new financial stress dataset developed by the International Monetary Fund, not only allows testing of whether central banks responded to financial stress, but also detects the periods and types of stress that were the most worrying for monetary authorities and quantifies the intensity of the policy response. Our findings suggest that central banks often change policy rates, mainly decreasing them in the face of high financial stress. However, the size of the policy response varies substantially over time as well as across countries, with the 2008-2009 financial crisis being the period of the most severe and generalized response. With regard to the specific components of financial stress, most central banks seemed to respond to stock-market stress and bank stress, while exchange-rate stress is found to drive the reaction of central banks only in more open economies.

Keywords: Endogenous regressors; financial stress; monetary policy; Taylor rule; time-varying parameter model. (search for similar items in EconPapers)
JEL-codes: E43 E52 E58 (search for similar items in EconPapers)
Date: 2011-07
New Economics Papers: this item is included in nep-ban, nep-cba, nep-mac and nep-mon
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Citations: View citations in EconPapers (13)

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Related works:
Journal Article: Time-varying monetary-policy rules and financial stress: Does financial instability matter for monetary policy? (2013)
Working Paper: How Does Monetary Policy Respond to Financial Stress? (2011)
Working Paper: Monetary Policy Rules and Financial Stress: Does Financial Instability Matter for Monetary (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:cnb:wpaper:2011/03

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