The Taylor Rule and Financial Stability – A Literature Review with Application for the Eurozone

Käfer Benjamin ()
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Käfer Benjamin: University of Kassel, Department of Economics, Nora-Platiel-Str. 4, 34127 Kassel, Germany

Review of Economics, 2014, vol. 65, issue 2, 159-192

Abstract: The question whether central banks should bear responsibility for financial stability remains unanswered. In connection with the use of interest rates, it is therefore not clear whether and how the Taylor rule should be augmented by an additional financial stability term. This paper reviews the normative and positive literature on Taylor rules augmented with exchange rates, asset prices, credit, and spreads. These measures have evolved as common indicators of financial (in)stability in the Taylor rule literature. In addition, our own analysis describes the development of these indicators for the core and the periphery of the Eurozone. Given the high degree of heterogeneity between euro area countries, the conclusion here is that an interest rate reaction to instability by the European Central Bank would be inappropriate in times of crisis. However, this conclusion is somewhat weakened if there is no crisis.

Keywords: Taylor rule; financial stability; sovereign debt crisis; Eurozone heterogeneity; exchange rates; asset prices; credit spreads (search for similar items in EconPapers)
Date: 2014
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DOI: 10.1515/roe-2014-0204

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