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Monetary policy and financial stability: what role for the interest rate?

Cristina Badarau () and Alexandra Popescu ()

International Economics and Economic Policy, 2015, vol. 12, issue 3, 359-374

Abstract: We propose an ex-post analysis of the behavior of a central bank confronted with financial turmoil. For this purpose, we rely on a DSGE model that combines credit market frictions with a boom and bust scenario on the price of capital. Within this framework, we seek to understand the extent to which central banks could have intervened to limit the effects of the financial bubble and its bursting. We compare the results obtained in terms of economic stabilization under a simple Taylor rule with those of an augmented rule that takes into account a financial indicator. We show that a central bank using as sole instrument the interest rate cannot simultaneously improve inflation and credit cycles. Copyright Springer-Verlag Berlin Heidelberg 2015

Date: 2015
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DOI: 10.1007/s10368-014-0307-6

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Handle: RePEc:kap:iecepo:v:12:y:2015:i:3:p:359-374