Optimal Monetary Policy Rules, Financial Amplification, and Uncertain Business Cycles

Salih Fendoglu ()

Working Papers from Research and Monetary Policy Department, Central Bank of the Republic of Turkey

Abstract: This paper studies whether financial variables per se should matter for monetary policy. Earlier consensus view - using financial amplification models with disturbances that have no direct effect on credit market conditions- suggests that financial variables should not be assigned an independent role in policy making. Introducing uncertainty, time- variation in cross-sectional dispersion of firms� productive performance, alters this policy prescription. The results show that (i) optimal policy is to dampen the strength of financial amplification by responding to uncertainty (at the expense of creating a mild degree of fluctuations in inflation). Moreover, a higher uncertainty makes the planner more willing to relax the financial constraints. (ii) Credit spreads are a good proxy for uncertainty, and hence, within the class of simple monetary policy rules I consider, a non-negligible response to credit spreads -together with a strong anti-inflationary stance- achieves the highest aggregate welfare possible.

Keywords: Optimal Monetary Policy; Financial Amplification; Uncertainty Shocks (search for similar items in EconPapers)
Date: 2011
New Economics Papers: this item is included in nep-cba and nep-mon
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Citations: View citations in EconPapers (5)

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Journal Article: Optimal monetary policy rules, financial amplification, and uncertain business cycles (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:tcb:wpaper:1126

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