Optimal monetary policy rules, financial amplification, and uncertain business cycles

Salih Fendoglu ()

Journal of Economic Dynamics and Control, 2014, vol. 46, issue C, 271-305

Abstract: This paper studies optimal monetary policy in the presence of ‘uncertainty’, time-variation in cross-sectional dispersion of firms׳ productive performance. Using a model with financial market imperfections, the results suggest that (i) optimal policy is to dampen the strength of financial amplification by responding to uncertainty (at the expense of creating mild degree of fluctuations in inflation). (ii) Higher uncertainty makes the welfare-maximizing planner more willing to relax financial constraints. (iii) Credit spreads are a good proxy for uncertainty. Hence, a non-negligible response to credit spreads – together with a strong anti-inflationary policy stance – achieves the highest aggregate welfare possible.

Keywords: Optimal monetary policy; Financial amplification; Uncertainty shocks (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (7)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:46:y:2014:i:c:p:271-305

DOI: 10.1016/j.jedc.2014.06.008

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