Monetary and Macroprudential Policy with Endogenous Risk

Tobias Adrian, Fernando Duarte, Nellie Liang and Pawel Zabczyk

No 14435, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We extend the New Keynesian (NK) model to include endogenous risk. Lower interest rates not only shift consumption intertemporally but also conditional output risk via the impact on risk-taking, giving rise to a vulnerability channel of monetary policy. The model fits the conditional output gap distribution and can account for medium-term increases in downside risks when financial conditions are loose. The policy prescriptions are very different from those in the standard NK model: monetary policy that focuses purely on inflation and output-gap stabilization can lead to instability. Macroprudential measures can mitigate the intertemporal risk-return tradeoff created by the vulnerability channel.

Keywords: Monetary policy; Macroprudential policy; Macro-finance (search for similar items in EconPapers)
JEL-codes: E32 E44 E52 G28 (search for similar items in EconPapers)
Date: 2020-02
New Economics Papers: this item is included in nep-dge, nep-mac and nep-mon
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Citations: View citations in EconPapers (18)

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Working Paper: Monetary and Macroprudential Policy with Endogenous Risk (2020)
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