Monetary Policy and Endogenous Financial Crises

Frédéric Boissay (), Fabrice Collard (), Jordi Gali () and Cristina Manea ()
Additional contact information
Frédéric Boissay: BIS - Bank for International Settlements
Fabrice Collard: TSE-R - Toulouse School of Economics - UT Capitole - Université Toulouse Capitole - Comue de Toulouse - Communauté d'universités et établissements de Toulouse - EHESS - École des hautes études en sciences sociales - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement
Jordi Gali: UPF - Universitat Pompeu Fabra [Barcelona]
Cristina Manea: BIS - Bank for International Settlements

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Abstract: Should a central bank deviate from price stability to promote financial stability? We study this question through the lens of a textbook New Keynesian model augmented with capital accumulation and search–for–yield behaviors that give rise to endogenous financial crises. Our main findings are fourfold. First, monetary policy affects the probability of a crisis both in the short run (through aggregate demand) and in the medium run (through savings and capital accumulation). Second, the central bank can lower the probability of a crisis and increase welfare compared to strict inflation targeting by responding to output and an index of financial fragility (the "yield gap") in addition to inflation. Third, "backstop" policy rules that prevent credit market collapses can further increase welfare. Fourth, financial crises may occur after a long period of unexpectedly loose monetary policy as the central bank abruptly reverses course.

Keywords: Backstops; Financial instability; Search for yield; Low–rate–for–long; Inflation targeting (search for similar items in EconPapers)
Date: 2023-04-08
Note: View the original document on HAL open archive server: https://hal.science/hal-05277518v1
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