Financial Instability and Optimal Monetary Policy Rule

Hossein Sedghi-Khorasgani

No 42, FIW Working Paper series from FIW

Abstract: This paper investigates the effect of financial instability on the design of monetary policy rule for a small open economy. We find evidence that optimal monetary policy rule reacts directly to financial imbalances and, as a result, to the real exchange rate movements. However, optimal rule would not react to the real exchange rate changes directly if central bank does not care about the financial instability. For a quantitative analysis, impulse responses of some macroeconomic variables and financial instability to the domestic productivity and foreign country output shocks, resulting from simulation, are also analysed in this paper.

Keywords: Financial instability; Optimal monetary policy rule; Real exchange rate; Open economy (search for similar items in EconPapers)
JEL-codes: E52 G01 (search for similar items in EconPapers)
Pages: 27
Date: 2010-01
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