Monetary Policy and Financial Stability

Isabel Cairo and Jae Sim

No 2020-101, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: The 2008 Global Financial Crisis called into question the narrow focus on price stability of inflation targeting regimes. This paper studies the relationship between price stability and financial stability by analyzing alternative monetary policy regimes for an economy that experiences endogenous financial crises due to excessive household sector leverage. We reach four conclusions. First, a central bank can improve both price stability and financial stability by adopting an aggressive inflation targeting regime, in the absence of the zero lower bound (ZLB) constraint on nominal interest rates. Second, in the presence of the ZLB constraint, an aggressive inflation targeting regime may undermine both price stability and financial stability. Third, an aggressive price-level targeting regime can improve both price stability and financial stability, regardless of the presence of the ZLB constraint. Finally, a leaning against the wind policy can be detrimental to both price stability and financial stability when the credit cycle is driven by countercyclical household sector leverage. In this environment, leaning with credit spreads can be more effective.

Keywords: Inflation targeting; Financial crises; Zero lower bound (search for similar items in EconPapers)
JEL-codes: E32 E52 G01 (search for similar items in EconPapers)
Pages: 36 p.
Date: 2020-12-18
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Journal Article: Monetary policy and financial stability (2023)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2020-101

DOI: 10.17016/FEDS.2020.101

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