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Monetary Policy Rules with Financial Instability

Sofia Bauducco, Ales Bulir () and Martin Cihak ()

Working Papers from Czech National Bank, Research Department

Abstract: To provide a rigorous analysis of monetary policy in the face of financial instability, we extend the standard dynamic stochastic general equilibrium model to include a financial system. Our simulations suggest that if financial instability affects output and inflation with a lag, and if the central bank has privileged information about credit risk, monetary policy responding instantly to increased credit risk can trade off more output and inflation instability today for a faster return to the trend than a policy that follows the simple Taylor rule. This augmented rule leads in some parameterizations to improved outcomes in terms of long-term welfare, however, the welfare impacts of such a rule appear to be negligible.

Keywords: DSGE models; financial instability; monetary policy rule. (search for similar items in EconPapers)
JEL-codes: E52 E58 G21 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-cmp, nep-dge, nep-mac and nep-mon
Date: 2008-12
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Journal Article: Monetary Policy Rules with Financial Instability (2011) Downloads
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