Output Gap in Presence of Financial Frictions and Monetary Policy Trade-offs

Francesco Furlanetto, Paolo Gelain and Marzie Taheri Sanjani

No 2014/128, IMF Working Papers from International Monetary Fund

Abstract: The recent global financial crisis illustrates that financial frictions are a significant source of volatility in the economy. This paper investigates monetary policy stabilization in an environment where financial frictions are a relevant source of macroeconomic fluctuation. We derive a measure of output gap that accounts for frictions in financial market. Furthermore we illustrate that, in the presence of financial frictions, a benevolent central bank faces a substantial trade-off between nominal and real stabilization; optimal monetary policy significantly reduces fluctuations in price and wage inflations but fails to alleviate the output gap volatility. This suggests a role for macroprudential policies.

Keywords: WP; monetary policy; Financial Frictions; Potential output; Optimal Monetary Policy; Output Gap; output gap stabilization; computing output gap; wage inflation; mark-up shock; asset price inflation; efficient frontier; output gap dynamics; monetary policy authority; implied output gaps; output gap in presence; inflation target shock; monetary policy shock; Wages; Inflation (search for similar items in EconPapers)
Pages: 44
Date: 2014-07-18
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Citations: View citations in EconPapers (11)

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