EconPapers    
Economics at your fingertips  
 

Financial vulnerability and monetary policy

Fernando Duarte () and Tobias Adrian ()

No 804, Staff Reports from Federal Reserve Bank of New York

Abstract: We present a microfounded New Keynesian model that features financial vulnerabilities. Financial intermediaries' occasionally binding value-at-risk constraints give rise to variation in the pricing of risk that generates time-varying risk in the conditional mean and volatility of the output gap. The conditional mean and volatility are negatively related: during times of easy financial conditions, growth tends to be high, and risk tends to be low. Monetary policy affects output directly through the investment-savings curve, and indirectly through the pricing of risk that relates to the tightness of the value-at-risk constraint. The optimal monetary policy rule always depends on financial vulnerabilities in addition to the output gap, inflation, and the natural rate of interest. We show that a classic Taylor rule exacerbates deviations of the output gap from its target value of zero relative to an optimal interest rate rule that includes vulnerability. Simulations show that optimal policy significantly increases welfare relative to a classic Taylor rule. Alternative policy paths using historical examples illustrate the usefulness of the proposed policy rule.

Keywords: macro-finance; monetary policy; financial stability (search for similar items in EconPapers)
JEL-codes: G10 G12 E52 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-fdg, nep-mac and nep-mon
Date: 2016-12-01, Revised 2017-02-01
References: Add references at CitEc
Citations: View citations in EconPapers (6) Track citations by RSS feed

Downloads: (external link)
https://www.newyorkfed.org/medialibrary/media/rese ... orts/sr804.pdf?la=en Full text (application/pdf)
https://www.newyorkfed.org/research/staff_reports/sr804.html Summary (text/html)

Related works:
Working Paper: Financial Vulnerability and Monetary Policy (2018) Downloads
Working Paper: Financial Vulnerability and Monetary Policy (2017) Downloads
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:fip:fednsr:804

Ordering information: This working paper can be ordered from

Access Statistics for this paper

More papers in Staff Reports from Federal Reserve Bank of New York Contact information at EDIRC.
Bibliographic data for series maintained by Amy Farber ().

 
Page updated 2020-01-17
Handle: RePEc:fip:fednsr:804