Incorporating Financial Sector Risk into Monetary Policy Models: Application to Chile

Dale Gray, Carlos García, Leonardo Luna and Jorge E. Restrepo

Working Papers Central Bank of Chile from Central Bank of Chile

Abstract: This paper presents a model for the financial sector’s vulnerability and integrates it into a macroeconomic framework commonly used in monetary policymaking. The main question to answer with the integrated model is whether central banks should explicitly include the financial stability indicator in the reaction function of the monetary policy interest rate. Our results show that, in general, including the banking industry’s distance to default (dtd) in the central bank’s reaction function reduces both inflation and output volatility. In addition, the results are robust to different calibrations of the model. Actually, there is gained efficiency from including the dtd variable in the reaction function whenever the pass-through coefficient of the exchange rate is higher and when financial vulnerability has a greater effect on the exchange rate and GDP (or, conversely, a higher effect of GDP in banking sector capital, which is here called endogeneity).

Date: 2009-12
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Citations: View citations in EconPapers (9)

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Related works:
Chapter: Incorporating Financial Sector Risk Into Monetary Policy Models: Application to Chile (2011)
Working Paper: Incorporating Financial Sector Risk Into Monetary Policy Models: Application to Chile (2011)
Journal Article: Incorporating Financial Sector Risk Into Monetary Policy Models: Application to Chile (2009)
Working Paper: Incorporation financial sector risk into monetary policy models: application to Chile (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:chb:bcchwp:553

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